What is Inventory and why is it Important to your Business?

By Randall Orser | Business Income Taxes

Your company’s inventory is what you sell to your customers.  It can either be purchased from a wholesaler and sold on-line or in your store, or it can be the raw materials that you use to manufacture products to sell.  It can also be component parts that you put together to make a product to sell. 

Inventory has value so it is an asset to your business and once you sell it you will be making money.  It also has value as collateral if you need a business loan.   The cost of selling your inventory (called cost of goods sold) is important for your business as it includes the cost of the items to make your product as well as the costs for storing inventory in your warehouse, shipping products to your customers and hiring people to work in the warehouse. 


Keeping Track of your Inventory – in both your accounting system and its physical location is important for your business:

  • To know how many items are in your inventory and their value as an asset on your balance sheet.
  • To know the costs associated with buying and selling inventory which are deductible business expenses that can reduce your business taxes.
  • Inventory costs and gross profit from sales are a major part of your business tax return.
  • The value of your inventory can be used as collateral for a loan.

Different Types of Inventory -  inventory can be divided into two categories:

  • Supplies – items sitting on the shelf waiting to be used.  These include office supplies, cleaning supplies, computer supplies and accessories.
  • Product inventory – this can be either items you buy wholesale to sell to customers or items manufactured and ready to sell, as well as components and raw materials.

Inventory and Cost of Goods Sold – Inventory is essential in calculating the cost of goods sold, which in turn is used to determine gross profit for a business that sells products whether it is a sole proprietorship, partnership or a corporation.  The cost of goods sold is calculated by:

  • Beginning inventory (your inventory at the beginning of the year, or the beginning of your business.
  • Add net purchases (calculated after discounts, allowances and returns).
  • This equals the Cost of Goods Available for Sale.
  • Less ending inventory, which is the value of your inventory at year end.

The closing inventory at the end of one year becomes the opening inventory at the beginning of the new year.  Businesses take physical inventory to make sure that what they have on record is correct.  At the same time, they can check for spoilage of obsolete goods and theft or bad record keeping which costs the business money.

From an article by Jean Murray

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About the Author

President/CEO Number Crunchers® Accounting Inc. Learn how to just say stuff it to this bookkeeping thing with our 'Just Say: "Stuff It" To Bookkeeping program.