Inventory Value Study Sheet

Accounting Terms

• Cost of Goods Sold is a measure of the direct cost involved in acquiring or producing goods that are, in turn, sold. The methods of measuring cost of goods sold are explained below, but a company's chosen method must be consistent with their method of measuring inventory value.
• Inventory represents finished and unfinished goods which have not yet been sold by a company.
• Inventory Valuation is a measure of the value of a comapny's unsold inventory. The methods of measuring inventory value are explained below, but a company's chosen method must be consistent with their method of measuring cost of goods sold.

Inventory Valuation

The value of a company's inventory can be calculated using one of the following methods:

Average Cost Method

• Assumes an inventory of non-unique goods (that is, every one is similar to every other one)
• Not generally recommended where prices are volatile
• Tends to even out price fluctuations over time
• Uses the average unit cost to calculate the value of current inventory:
• Average Unit Cost = (Total Unit Cost)/(Total Quantity of Units)

Inventory Value = (Average Unit Cost) x (Units of Current Inventory)

FIFO (First In, First Out) Method

• Assumes an inventory of non-unique goods (that is, every one is similar to every other one)
• Generally preferred inventory valuation method
• Assumes inventory is sold in the order that it is stocked, with the oldest goods sold first and the newest goods sold last
• Uses the unit cost per batch of acquired/produced goods, and counts the inventory backwards from the newest batch:
• Unit Cost per batch = (Cost/Quantity) for each batch

Inventory Value = (Unit Cost x Quantity) for each batch

LIFO (Last In, First Out) Method

• Assumes an inventory of non-unique goods (that is, every one is similar to every other one)
• Is highly regulated (or, in some cases, illegal) as a method for measuring inventory value
• Assumes newest inventory is sold first, with the oldest goods sold last
• Uses the unit cost per batch of acquired/produced goods, and counts the inventory forwards from the oldest batch:
• Unit Cost per batch = (Cost/Quantity) for each batch

Inventory Value = (Unit Cost x Quantity) for each batch

Inventory Rates and Ratios

These rates and ratios can be useful in analyzing a company's inventory levels:

Inventory Turnover Rate At Cost

• Measures inventory turnover over a period of time, as defined by the starting and ending dates
• Given the cost of goods sold, starting inventory value at cost, and the ending inventory value at cost (all from the balance sheet):

Average Inventory Value at Cost = (Starting Inventory + Ending Inventory)/2

Rate = (Cost of Goods Sold)/(Average Inventory Value at Cost)

Inventory Turnover Rate At Retail

• Measures inventory turnover over a period of time, as defined by the starting and ending dates
• Given the cost of goods sold, starting inventory value at cost, and the ending inventory value at cost:

Average Inventory Value at Retail = (Starting Inventory + Ending Inventory)/2

Rate = (Net Sales)/(Average Inventory Value at Retail)

Inventory Turnover Ratio

• Demonstrates the company's ability to convert inventory into cash, and is one predictor of a company's liquidity
• Generally a higher ratio is better, but values should be compared with industry averages for the best interpretation
• Given a company's sales (from the income statement) and inventory value (from the balance sheet):
• Inventory Turnover Ratio = (Sales)/(Inventory Value)