For many businesses, inventory is a primary component of their fixed assets. Businesses rely on their inventory to meet their customer demands, either by using the inventory to produce goods for the customer, by reselling the inventory to the customer or by using the inventory to serve the customer. Accountants classify inventory as a current asset and report inventory on the balance sheet with other current assets.
Merchandisers rely on inventory to meet their customers’ needs. Merchandisers purchase items from a variety of manufacturers and resell those items to their customers. Merchandisers report the ending balance of merchandise inventory in the current assets section of the balance sheet. Merchandise inventory that the company sold during the year represents an expense for the company. This expense shows up on the income statement as cost of goods sold. Cost of goods sold reduces the net income for the company.
Manufacturers purchase raw materials from their suppliers and convert those materials into finished products. Customers purchase the finished products from the manufacturer either for their own use or to resell. Manufacturers report three types of inventory in the current assets section of the balance sheet. These are raw material inventory, work in process inventory and finished goods inventory. Raw material inventory represents the materials received from suppliers that have not been used yet. Work in process inventory represents products the company started production on, but has not finished. Finished goods inventory represents products that are ready to ship to customers. Finished goods inventory that the company sold to customers during the year represents an expense to the company. This expense shows up on the income statement as cost of goods sold. Cost of goods sold reduces the net income for the company.
Service Provider Inventory
Service providers rely on inventory to facilitate service to their customers. The inventory of a service provider consists primarily of supplies needed to perform the service. Service providers report the ending balance of supplies inventory in the current assets section of the balance sheet. Supplies inventory that the company used during the year represents an expense for the company. This expense shows up on the income statement as supplies expense. Supplies expense reduces the net income for the company.
Analysts use the inventory value from the balance sheet to determine how effectively the company manages its inventory levels. One common analysis technique for inventory involves calculating the inventory turnover ratio. The inventory turnover ratio determines how many times the company sells and replaces its inventory throughout the year. The higher the inventory turnover ratio, the more the company moves its inventory and earns revenue from the sale of inventory.