On your balance sheet, inventory should be categorized as a current asset and should include raw materials, work-in-progress, and finished goods. Since inventory is extremely liquid, the balance sheet needs to be tracked to the most current state to remain accurate. Properly managing inventory can position businesses to be ready to grow, utilize financing, identify opportunities, and so much more. As you implement best practices your business can be one step closer to reaching its full potential. So, here’s what you should know about analyzing inventory on a balance sheet.
The importance of analyzing inventory for businesses
Inventory is a major investment for most businesses. Failing to analyze inventory can be the start of a domino effect for negative impacts. The most important reason to analyze inventory is to know just how much inventory you need. When it comes to inventory, too much or too little can cause problems. Therefore, you truly want to know just the right amount to protect cash flow and capture as many sales as possible. Remember that the right amount can vary depending on sales trends so inventory needs to constantly be analyzed.
Types of inventory
As we mentioned earlier, inventory is included on a balance sheet as a current asset which includes the following:
- Raw materials inventory: Raw materials are classified as materials that are used to create and finish inventory. By the time the end product is complete, these materials are often unrecognizable, which can make them harder to account for. No matter how small a material is, it should be accounted for.
- Work-in-progress inventory: Itemizing work-in-progress inventory can get a bit more complicated as it can include raw materials. Work-in-progress should include inventory or items that are currently in production and can include overhead packaging materials, and labor.
- Finished goods inventory: Let’s keep this simple – items that are ready to sell.
- Consignment inventory: If you sell inventory on consignment, you could classify inventory that is being held on consignment.
The idea here is to know where inventory is as it flows through production. As you can imagine this gets complicated when tracking manually so it can be extremely beneficial to invest in inventory management systems to keep your balance sheet and inventory count accurate. If you don’t manufacture products, tracking inventory is simpler, but should not be overlooked.
Analyzing Inventory Ratios
- Inventory turnover ratio = cost of goods sold / average inventories
- Gross profit margin = (revenue – cost of goods sold) / Revenue
- Days in inventory = days sales in inventory / (inventory/cost of goods sold * 365)
- Stock-to-sales ratio = average stock value / net sales value
Tips to identify inventory trends
To effectively identify inventory trends you’ll need sales for an extended period under your belt. While inventory management is often overlooked in the infant stages of a startup, this can be a costly mistake. The sooner you start collecting data and monitoring sales, the sooner you can understand and track trends as they relate to your business. Some industries may see trends and while it’s important to be aware, it’s more important to understand the trends of your business.
Here are 3 tips that can help identify inventory needs:
- Monitor highs and lows
- Implement an inventory management system
- Collect data to understand the driving factor for the trend
Identifying Risks and Opportunities in Inventory Analysis
As a business owner, risk is impossible to avoid. However, whenever possible, business owners should understand risks and how to control them. Thankfully, when it comes to inventory there are proactive approaches to managing risk. Here are some risks to be mindful of as you build your strategy.
- Overstocking and understocking risks: Overstocking inventory can result in cash flow problems, loss of value, increased costs, and more. Understocking inventory can result in lost sales. Neither present risks that need to be taken, even more reason to invest in inventory management to stock just the right amount of inventory. Running an efficient operation can save money and improve performance all around. As a business owner, it’s always important to take a step back to truly understand the impacts of all decisions. By managing overstocking and understocking risks you can fulfill orders faster, improve customer satisfaction, free up cash flow, and so forth. All positive impacts. Of course, there’s always the risk that products won’t sell or trends will change but that’s a whole other topic. Do what you can with what you know.
- Obsolescence and spoilage risks: Products can lose their competitive edge or become obsolete as they can spoil – both have the same impact. The variance here is the type of product we are talking about. If you fear either of these risks, consider monitoring inventory more closely, finding ways to sell what you have before it’s too late, or discontinuing the product altogether. It’s tempting to keep products around as long as possible but it may be a better business move to shift your resources into new products if you feel either of these risks are present.
- Opportunities for growth through inventory optimization: Optimizing your inventory allows you to lean operations, creating tremendous growth opportunities. When we talk about risk, opportunity usually isn’t far away. As you find ways to mediate risks, focus on the opportunities that can stem from the solutions you pose. As a business owner, always look ahead, keep a good attitude, and work to uncover hidden opportunities.
- Opportunities for cost savings through inventory management improvements: Investing in inventory management can cut costs including storage fees, liquidation, interest in inventory loans, and so forth.
A balance sheet is designed to provide a detailed overview of assets, liabilities, and capital at any given time for a business. Product-based businesses must include inventory, at all stages, on their balance sheet. While you can achieve success by shortcutting this, it’ll catch up to you in the long run. Plus, if you need funding for inventory or operations, you’ll likely need a record of sales and a healthy balance sheet.
To recap, some steps you can take to analyze inventory include:
- Identify all types of materials and stages of production
- Invest in inventory management systems
- Identify all costs associated with inventory
- Track sales trends
- Gather consumer data to understand trends
As your business grows, the need for funding may arise. At Kickfurther you can get inventory now and pay later, all while having fun doing so. Our platform connects business owners to a community of backers that can fund up to 100% of inventory.
- No immediate repayments. You control repayment. Don’t pay until your product sells.
- Non-dilutive. Maintain equity in your business, we know how hard you worked for it. We are here to work with you, not against you.
- Not a debt. Because you have enough financial strain, this is not a loan.
- Upfront capital. Pay suppliers faster with upfront capital, there when you need it.
When you turn to any type of inventory financing, you’ll need to present the facts and financials to prove your ask. Analyzing inventory at every stage of growth equips you with the information you need to get buy-in from lenders or other sources that can provide funding. Plus, it allows you to clearly navigate the path to success. It’s scary to face reality in some circumstances, but the sooner you do it, the sooner you can find solutions to problems – which we know is what we entrepreneurs do best!