Inventory

For a shop, inventory is the stock on its shelves and in its storeroom. For a manufacturer, it includes raw materials, work in progress and finished goods ready for sale. Inventory is recorded as a current asset on the balance sheet, because it is expected to be sold within a year.

When inventory is sold, its cost moves from the balance sheet to the income statement as cost of goods sold. The difference between the selling price and that cost gives gross profit.

Valuing inventory involves choices. When identical items were bought at different prices, the business must decide which cost to assign to the items sold. Common methods include first-in, first-out (FIFO), which assumes the oldest items are sold first, and weighted average cost. Accounting rules also require inventory to be reduced in value if it can only be sold for less than it cost.

Managing inventory is a balancing act. Too little means lost sales; too much ties up cash, needs storage and risks becoming damaged or out of date. Businesses track how quickly inventory sells to strike the right balance.