Inventory management plays an important role in the operations of businesses. It involves effectively tracking the goods a company has available for sale. This process is essential for making informed decisions about purchasing and selling. This not only saves money but also ensures customer satisfaction.
In this article, we will explore all the information you need to know about inventory in accounting.
Key measures of inventory
Businesses need inventory accounting metrics to manage their stock, improve cash flow, and keep profits. The 3 key measures of inventory are:
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Inventory Turnover Ratio: This is like a measure that tells us how well a company uses its stuff for sale. It shows how many times they sell and replace their stuff in a certain time.
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Days inventory outstanding (DIO): Imagine a clock that shows how long it takes for a company to sell their stuff. The lower the number on the clock, the faster they sell things.
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Gross Margin Return on Inventory Investment (GMROI): This is like a measure of how much money a company makes compared to the money they spend on keeping things to sell. If the number is high, it means they make more money than they spend on having stuff.
One can go through the inventory management KPI PDF for more detailed information to get a better idea.
What Is Inventory Accounting Metrics
Inventory accounting metrics refer to a set of key performance indicators (KPIs) and financial measurements. This is used to evaluate a company's inventory management practices’ efficiency, effectiveness, and economic impact.
Inventory performance metrics provide valuable insights into how well a business manages its inventory.
This tool makes it easy for businesses to understand how well they're managing their things for sale. It's like a special magic window that shows them important things so they can make good decisions. An inventory KPI dashboard is a visual tool that provides real-time details into key performance indicators related to inventory management. It helps businesses observe:
- inventory turnover: It helps them know how quickly the things they have are getting sold.
- stock levels: It also shows how much stuff they still have left in their storage.
- stockouts: The tool also lets them know if they're running out of stuff.
Read Also: What Is Purchase Order Management Software?
Inventory Turn Or Turnover
Inventory turnover, also known as inventory turn, is an important financial metric used by businesses. They use it to assess the efficiency of their inventory management and how quickly they sell and replace their inventory.
For businesses, a high inventory turnover usually means they're doing well because they're selling things quickly and making money. A low turnover might mean they need to make changes in how they manage their stuff to improve their sales and make things work better. So, this measurement is like a helpful tool that gives businesses a signal about how they're doing with their sales and inventory.
Inventory KPIs for retail include inventory turnover, stockout rate, and sell-through rate.
The inventory accuracy KPI formula:
The inventory turnover ratio is calculated using the following formula:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
Where Cost of Goods Sold (COGS) represents the total direct costs associated with producing or purchasing the goods sold during the period.
To calculate Average Inventory, simply add the beginning and ending inventory values for the time and divide the sum by 2.
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Interpreting Inventory Turnover:
A higher inventory turnover ratio generally means that a company efficiently manages its inventory.
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It means the company sells its inventory quickly, reducing the risk of holding excess stock and potentially outdating it.
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A high turnover ratio indicates strong demand for the company's products and efficient supply chain management.
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When a company has a higher inventory turnover ratio, it's like they're using their money smartly. They're not keeping too much stuff sitting around, This means they don't have too much money tied up in things that haven't been sold yet.
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With a higher turnover ratio, the company isn't keeping things for too long. This reduces the chance that the items might become outdated or unusable before they are sold.
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A high turnover ratio often suggests that the company is good at knowing what customers want and providing it to them quickly. This can make customers happy because they get what they want when they want it.
Inventory Carrying Cost
Inventory carrying cost, or holding cost, refers to the expenses of a business to store and maintain its inventory over a specific period. These costs are important for companies that have inventory.
Inventory Aging
Inventory accounting metrics are important for businesses to manage their
- inventory
- optimize cash flow
- maintain profitability.
The process of inventory aging involves dividing inventory items into different groups based on time intervals. The most common age categories are typically in days, such as
- 0-30 days
- 31-60 days
- 61-90 days, and so on.
Each category represents the time elapsed since the items were received into inventory or since their last sale.
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Here's how inventory aging works:
1. Classifying Inventory
Inventory items are grouped based on the time elapsed since receipt or last sale.
For example, products in stock for 0-30 days are placed in the first age category. Those in stock for 31-60 days in the second category, and so on.
2. Monitoring Movement
The inventory aging report is regularly updated to reflect changes in stock levels and sales. New inventory received is added to the appropriate age category, and sold items are moved out of the report.
3. Analyzing Aging Data
Analyzing the inventory aging report provides insights into inventory movement over time.
4. Inventory Management Decisions
Based on the analysis, businesses can make informed decisions about inventory management.
Read Also: What Is Purchase Order Management Software?
Tranzact: Streamlined Inventory Management Solution
TranZact offers an innovative platform for optimizing inventory management:
1. Inventory Turnover Ratio
It gauges the speed at which inventory is sold and restocked. A high ratio indicates efficient inventory management and lower carrying costs.
2. Days Inventory Outstanding (DIO)
Calculates the average time to sell inventory. This helps identify slow-moving items and manage cash flow.
3. Gross Margin Return on Inventory Investment (GMROI)
Evaluate profitability based on inventory investment. High GMROI signifies the effective use of inventory for generating profit.
FAQs On Critical Inventory Accounting Metrics
1. What are critical inventory accounting metrics?
Critical inventory accounting metrics are KPIs for inventory accuracy used to evaluate and assess a company's inventory management practices.
2. Why should businesses track inventory accounting metrics?
Tracking inventory accounting metrics is essential for
- optimizing inventory levels
- reducing carrying costs
- improving overall financial performance.
3. What are some standard inventory accounting metrics businesses should track?
Some common inventory accounting metrics, also known as inventory metrics examples, include
- inventory turnover ratio,
- days inventory outstanding (DIO),
- gross margin return on inventory investment (GMROI)
4. How can the inventory turnover ratio help businesses?
A higher turnover ratio indicates efficient inventory management and reduced risk of holding excess stock.
5. What is the importance of the carrying cost of inventory?
The carrying cost of inventory represents the expenses related to storing and maintaining inventory.
6. How can businesses use stockout rates to improve customer satisfaction?
The stockout rate assesses how often inventory shortages occur. By tracking this metric, businesses can identify inventory management issues and improve their supply chain.
