How to Analyze Inventory on a Balance Sheet

December 30, 2022

Running a business requires a lot of patience and a desire to learn from your day-to-day experiences. These two qualities are essential to help keep abreast of competitors and grow your business. A keen understanding of your finances is critical to keeping your business in good shape.

One of the most important ways to keep your business in good shape is inventory analysis. Understanding your inventory helps give you an idea of your business expenses. Reviewing your inventory can be a daunting task, but it's manageable once you know how to do it.

Here's everything you need to know about reviewing your inventory.

What Is a Balance Sheet?

A balance sheet contains a business's assets and liabilities during a set period. Balance sheets detail how much a company is worth. Balance sheets describe the financial health of a business.

Accounting teams in business use balance sheets to ascertain how it is doing. They can use this data to advise the business's leadership on changes they should make to keep the company financially healthy.

What Is on a Balance Sheet?

Balance sheets list all of a company's assets within a given period. When done correctly, a company's liquid assets should be at the top of the balance sheet. By listing assets in order of liquidity, a company should be able to determine how much liquid cash it has available.

Here are several items you may find on a balance sheet.

Current Assets

Current assets are things a business owns that can turn into cash within a year.

Cash, checks, or equivalents to cash consist of cash in your business checking or savings account.

Inventory includes materials, projects under development, and finished projects.

Prepaid expenses include anything your business pays before the bill is due. Prepaid expenses include rent, insurance, or an internet bill.

Outstanding accounts receivable means that if your company offers products or services that customers have to pay for, they should receive an invoice or receipt. The cash incoming from that payment is a current asset.

Long-term Assets

Long-term assets are unlike current assets in that they will not convert to cash within the following year. Long-term assets can include:

• Fixed assets, which are things like real estate, buildings, computers, equipment, and machinery
• Investments you cannot divest within a year
• Intangible assets, which include patents and copyrights

Liabilities

Money that your business owes is a liability. Liabilities come in two forms: current and long-term liabilities.

Current liabilities are expenses that you will have to pay shortly. These expenses are generally monthly or recurring charges. Some expenses that qualify as current liabilities include payroll, interest, rent, and taxes.

Long-term liabilities are expenses that a company will pay over a long period. Loans and deferred taxes are two examples of long-term liabilities. If your business offers a pension, this is also considered a long-term expense.

Shareholders' Equity

Shareholders' equity is the net worth of the business. You can determine the shareholders' equity by subtracting the business's liabilities from its assets.

Days Inventory Outstanding

The days inventory outstanding is a ratio that calculates how long a business holds inventory before it sells it. To calculate the ratio, divide the inventory by the cost of goods sold and multiplied by 365. The ratio varies across different industries.

However, it can be helpful when compared to businesses within the same industry.

A ratio that increases over time and is higher than its competitors can indicate that the business is struggling to clear its inventory. Holding unsold inventory costs businesses money because their money is in a stagnant resource that doesn't benefit it until it's sold.

It can be costly to store inventory, especially when there are additional costs to hold it.

In some industries, inventory can become obsolete. When it becomes obsolete, businesses lose money on what they could have made on their unsold inventory. To try and recoup a fraction of what they spent on it, a company may have to sell it at a significant discount.

Inventory management can help businesses manage their inventory and how long its been unsold.

What Is Inventory Analysis?

Inventory analysis helps businesses determine how much product to keep on hand to meet customer demand. Business owners also need to manage the costs of storing their inventory to keep their businesses profitable.

On a balance sheet, inventory is counted as an asset. This is because inventory represents the products that a business plans to sell to customers. Inventory counts as a couple of other things, too.

The materials needed to produce a finished project count as inventory as well. Unfinished products meant to be sold also qualify as inventory.

Turnover and Accounts Payable

To find the turnover ratio, the average inventory balance between two periods is needed for the calculation. Net sales or cost of goods sold can be the numerator. The cost of goods sold is preferred since it better represents the inventory that a business has on hand at that moment.

To calculate accounts payable turnover, the value of purchases has to be the numerator. This value has an indirect impact on the inventory account. Some inventory may be purchased on credit. Because of this, this impacts the accounts payable account.

Inventory Turnover

To calculate inventory turnover, you need to calculate the ratio of the cost of goods sold to the average inventory. In some cases, revenues are used in place of the cost of goods sold, and the average inventory balance is used instead. Inventory turnover is an essential statistic for businesses with a physical inventory.

This value shows how much inventory is sold throughout the fiscal year.

Inventory turnover should be compared to industry competitors since these values differ between industries. Low turnover on a downward trend does not bode well for a business's viability.

Determining Inventory Value on a Balance Sheet

There are four categories of inventory to account for: raw materials, works in progress, finished products, and overhaul.

As mentioned, inventory can be split into current and long-term assets. You need to determine your existing assets to calculate inventory value. Long-term assets do not count as inventory on balance sheets.

Once you determine the current assets, you need to figure out how much you have and what it's worth. There are three ways you can do this.

Use Inventory Management Software

Inventory management software is a quick way to analyze inventory. For example, you can input your inventory and tag each item as a current or long-term asset. Once you do this, you can generate reports for each quarter.

By filling out the details of your inventory, you can have all the pertinent information you need for your balance sheet and reports.

Calculate Ending Inventory

You can also calculate the value of inventory by calculating the ending inventory. You can calculate ending inventory by adding beginning inventory and purchases and subtracting the cost of goods sold.

Doing a Manual Inventory Count

If your inventory count isn't up-to-date, you may need to halt operations and physically count inventory. Without a way to keep your inventory counts on hand, you'll have to do counts when you need that data. Counts can take hours or even up to a few days, depending on how much inventory you have.

Inventory to Sales Ratio

The inventory to sales ratio is the ratio of inventory to revenue. An increase in this ratio can indicate that a business has more inventory than it can liquidate in sales. It can also indicate a decrease in sales.

A decrease in the ratio can indicate that a business isn't producing enough products to keep up with demand. Inventory to sales ratio provides a sweeping view of the balance sheet. The picture it provides can indicate if a more in-depth view of a business's inventory is necessary.

Gaining A Comprehensive View of Inventory Management Is Essential

Inventory analysis is a crucial metric to determine the health of a business. By understanding your quarterly sales metrics, you can determine if you need to scale back on production or produce more. Inventory management software is a simple way to help you track business metrics and allows you to spend more time providing an excellent product to your customers.

Britecheck can help you stay on top of inventory data whenever you need it. You can access it via your phone or tablet. There are pricing plans that are perfect for small businesses or corporations.

Sign up today to get started.