There are several inventory valuation methods to determine your company’s asset value. As a BigCommerce business owner, it’s important to know which works best for your company and how they affect your bottom line.
This blog post will discuss some of the most popular ways to calculate an asset value on inventory, highlighting the pros and cons of each method.
Weighted Average Cost
The weighted average method, also known as the average cost inventory method, uses an average to determine how much money goes into the COGS and items in inventory. To get your WAC per unit, divide the cost of goods available for sale by the number of units.
This weighted average cost inventory valuation method is often used because it’s simple and easy to understand.
A significant advantage of the weighted average cost method is that it gives a good estimate of the overall inventory value. The only major disadvantage of the weighted average cost inventory valuation method is that it can be affected by changes in the actual cost of individual items in stock. For example, if the price of a commodity increases, the weighted average cost per unit will also go up.
This method is suitable for companies that sell various non-perishable items where the products have very different costs. Inventory storage costs calculations are multiplying the price per unit by the number of teams in the inventory.
With the specific identification inventory valuation method, each product unit receives a unique identifier. You can track the cost of individual units in physical inventory, which is ideal when you need to keep a close eye on prices.
This is the most precise of the methods here because it assigns a unique value to each item in stock. It’s the ideal option for companies selling homogeneous products, such as grocery items, that will not change much.
The primary drawback is net income is changeable on financial statements.
Inventory valuation using this method works best for companies that sell single items or small groups of very similar things.
To estimate inventory storage costs when not tracking products separately:
Multiply the unit cost by the number of units in stock and the products shipped.
First In First Out (FIFO)
With FIFO cost valuation, you base costs of inventory on chronological order. The valuation uses the first unit purchased for the cost basis, so it’s sold again.
The FIFO method assumes the first products in inventory are the first to leave. This is a more accurate method, as it avoids overstating the value of your inventory assets.
Here, you value inventory based on most recently incurred costs. It is less useful when business is slow since it doesn’t consider inflation.
Inventory valuation using the first-in, first-out method works best for companies that sell homogeneous interchangeable products with steady demand. It’s most common with perishable inventory. Inventory storage costs are estimated by multiplying the price per unit of the most recently purchased units by the number of units in stock.
Last In First Out (LIFO)
With LIFO cost valuation, you base inventory costs on reverse chronological order. The valuation uses the last unit purchased for the cost basis.
The biggest benefit of LIFO is the tax advantage it offers. During times of inflation, LIFO results in a higher cost of goods sold and a lower balance of remaining inventory. A higher cost of goods sold means a smaller tax liability.
An understated inventory position may cause your working capital make look worse than it is. LIFO may cause an underestimate in your stocks. It can negatively affect profitability and growth potential.
Inventory valuation using the last-in, first-out method works best for companies that sell homogeneous interchangeable products with erratic demand. LIFO accounting is only legal in the United States.
Inventory valuation methods are important because they heavily influence operations, from pricing decisions to tax strategies.
To make informed decisions about your company’s finances and how much inventory to purchase, you must understand which inventory valuation methods to use and why. Regularly conduct inventory valuation throughout the accounting period. It ensures you have the right list you need and is a financial health indicator. In this case, refer to BackOrder, an application that can help you to eliminate dead, excess stocks by notifying you of the situation in your warehouse.