When running a business, many responsibilities jockey for your attention, but one of the most important is inventory management. The way you handle your inventory can have a large impact on the profitability of your company overall. Making mistakes in inventory management can cause problems in the financial statements and to the bottom line, which directly affects profit and loss.
Businesses that have problems managing inventory can lose substantial amounts of profit. When inventory is lost to theft, damage or mistakes, it is essentially like throwing profit away. As a business, you have to invest capital into the inventory that you buy. Unless you turn around and sell that inventory, you cannot recoup the initial costs or generate any profit. This makes managing your inventory a top priority for your business. Many otherwise profitable businesses have run into problems due to inventory issues.
In some cases, you may not actually lose any inventory, but simply misstate how much you have on hand. This can make your company appear more or less profitable than it actually is on financial reports. If the inventory is overstated, it decreases the cost of goods sold. This makes the company look more profitable than it actually is. If the inventory is understated, it makes the company look less profitable. This can make it difficult to attract investors or qualify for loans.
One Mistake, Two Statements
Inventory errors are problematic because they can cause two sequential financial statements to be incorrect. When an inventory error occurs, it causes the current statement to be over or understated. Then when the inventory is counted again, the subsequent financial statement will be off because it will make the inventory off in the opposite direction. This leads to two financial statements in a row being incorrect. Because of this large impact, it is critical to have a consistent method of tracking inventory.
Many businesses delay investing in a quality inventory management system because of the relatively large financial investment involved. While it may require a big investment, it is typically well worth the cost. By tracking the inventory accurately, you have a better chance of catching any potential errors before they occur. While a tracking system will not eliminate the potential for damaged or lost inventory, it can help eliminate the errors that affect the company's financial statements.
- Accounting Coach; Why Does an Inventory Error Affect Two Periods?; Harold Avercamp
- Trinity Group: Keeping Score...Inventory Management - Turning Inventory into Profit
- Cliffs Notes: Inventory Errors and Financial Statements
- Masao Nakamura, Sadao Sakakibara and Roger Schroeder. "Adoption of Just-in-Time Manufacturing Methods at U.S.- and Japanese-Owned Plants: Some Empirical Evidence," pages 230-231. IEEE Transactions on Engineering Management, 1988.
- Electronic Code of Federal Regulations. "Regulation S-X, 17 CFR Part 210: Sec. 210.5-02 Balance sheets." Accessed Aug. 1, 2020.
Luke Arthur has been writing professionally since 2004 on a number of different subjects. In addition to writing informative articles, he published a book, "Modern Day Parables," in 2008. Arthur holds a Bachelor of Science in business from Missouri State University.