The Importance Of Analyzing The Inventory Periodically

Inventory costing and analysis are important to all business owners no matter the size of the business. Inventory costing allows businesses to know how much their current inventory is worth. There are three types of inventory costing methods (1) First In, First Out (FIFO), (2) Last In, First Out (LIFO), and (3) Weighted Average (WA). The method a company uses depends on the financial goals it sets for itself. Analyzing the inventory periodically is important for a business to see what still available to sell and at what cost. 

The first inventory costing method is FIFO, which assumes that the oldest inventory is the first to come out of the warehouse to be sold. Since this method shows a higher gross profit, it would be best for companies that are looking to attract investors. Also, if inventory prices are increasing throughout the year it would be good for businesses who are looking to expand the company with bank loans. 

The second costing method is LIFO, which is the opposite of the FIFO because it assumes the newest inventory is removed from the warehouse to be sold. LIFO yields the lowest gross profit, which can be best if your company’s goal is to save on taxes. Under the LIFO method, if prices decrease throughout the year it would be helpful to get loans for expansion. 

The final inventory costing method is WA. WA does not depend on what items are sold first, instead, it averages the items bought throughout the year. Using this method puts the gross profit between the FIFO and LIFO, which can be good if the market significantly fluctuates throughout the year. Since WA is between both FIFO and LIFO it could be helpful to any business. If the business is looking to attract investors and save on taxes, compared to the FIFO method, or if it is looking to get a loan to expand the business but the market prices are all over the place. 

Analyzing these methods side by side can help a company decide on which method is best for their needs. Although companies can change their inventory method if their needs change or with the changing of the market it is best if they do not change the method too often since it could create questioning and cause difficulty when it comes to bookkeeping.

When starting a business, it is important to know what your company’s needs are going to be to decide which inventory costing method to choose. Once your company chooses a method it is best to stick with it for simplicity in bookkeeping. However, if the need arises you can change the method which your company uses. Changing methods can be helpful when the market fluctuates but can be damaging to the company if it is changed too often. If your company changes the method too often investors, banks, and the government are going to question your motives. 

I think the article helped me to understand the different methods and why a company would choose different methods. I think if I were going to use any of the methods it would be the WA because it seems simpler to understand and calculate. However, if a company has different financial goals then it needs to choose the method which is going to be of the most benefit for the goals it set.