Inventory is an essential source of potential revenue regardless of whether your business handles components, raw materials, or finished products. It’s a major investment and a crucial part of your total current assets.
Inventory is a current asset because the business plans to sell it within the next accounting period (or within 12 months from when it's recorded on the balance sheet). Current assets include items that are either cash or cash equivalents or can be converted into cash within a year.
Let’s understand why inventory is a current asset, how to calculate it, and the best ways to manage inventory.
What Is Inventory?
Inventory or stock includes the goods and materials a business holds for resale, production, or utilization. It includes both raw materials used in production and finished goods that are available for sale. The purpose of holding inventory is to facilitate resale or production. Determining the shape and placement of these stocked goods is called inventory management.
Inventory on the balance sheet is considered a current asset alongside liabilities and owner’s equity. As a business owner, you must aim to predict consumer demand as accurately as possible to prevent having too much or too little inventory.
Keep reading if you’re interested in learning how to manage your inventory and assess your stock accurately effectively.
Types of Inventory
Here’s an overview of the main types of inventory:
Raw Materials
These can include:
- Commodities like fabrics, steel, or lumber.
- Components such as electric motors, wire, or microchips are purchased by businesses to produce goods. For example, a manufacturing company may need precious metals and steel as raw materials.
Work in Progress
This category includes all products that are not yet finished or ready for sale. Examples include:
- Unassembled parts of a car.
- Unbaked pottery.
Finished Goods
These are complete products that are ready for sale. Examples range from a box of cookies to an expensive sports car.
Is Inventory a Current Asset or Fixed Asset?
Inventory is classified as a current asset because businesses expect to sell it within the next year. This expectation is why inventory appears under current assets on the balance sheet.
However, there are instances when some inventory may remain unsold due to factors like unpredictable customer demand, shipment delays, and other challenges. Excess inventory can lead to lost revenue and disrupted cash flow, especially if products spoil, become outdated, or fall out of fashion.
Despite these challenges, inventory is still considered a current asset because its useful life generally does not exceed one year.
In contrast, fixed assets are items that provide benefits to a business for more than one accounting period, such as large equipment, buildings, land, and plants. Since it is expected to be converted into cash within a year, inventory can not be a fixed asset.
Current Assets
Current assets are assets that can reasonably be expected to be sold, consumed, or exhausted during a business's normal operations within the current fiscal year, operating cycle, or financial year. In other words, current assets are held for a relatively short duration. Some examples of current assets include cash, cash equivalents, accounts receivable, inventory, marketable securities, prepaid expenses, and other liquid assets.
Let’s look at an example. For a grocery company called ABC that generated $12,980 million in revenue during the first quarter of a year, their current assets would include:
- Cash and cash equivalents: $250 million
- Accounts receivable: $1,950 million
- Inventory: $8,500 million
- Marketable securities: $700 million
- Prepaid expenses: $600 million
- Other liquid assets: $1,150 million
Fixed Assets
Fixed assets (or noncurrent assets) are tangible items a company owns and uses in its operations to deliver goods and services, which ultimately help generate income. These can include things like equipment and property, and they provide long-term financial benefits for the business. Also known as long-lived assets or property, plant, and equipment, fixed assets are different from current assets, such as cash or bank accounts, because they aren’t easily converted into cash.
Fixed assets generate revenue, whereas inventory is classified as a current asset because it is expected to be converted into cash within one business year.
Why Are Inventories Reported as Current Assets?
In terms of liquidity, inventory falls somewhere in the middle of the spectrum. While it's less liquid than short-term investments like cash and cash equivalents, it's significantly more liquid than assets like land or equipment.
Most businesses can liquidate this inventory within a year, which is why it's classified as a current asset. However, there are circumstances where inventory might be viewed as a long-term asset.
Several factors can influence whether inventory remains a current asset. Different industries have varying inventory turnover rates; some can sell inventory faster than others. Economic downturns can also make it more challenging to sell inventory. Demand is always fluctuating so this can also impact a company’s ability to liquidate inventory within a year.
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Understanding the Current Assets Formula
To calculate your total current assets, subtract the total of your current liabilities from your total current assets. This figure represents your business's net value (before taxes and interest) at any given time, commonly referred to as its book value or shareholders' equity.
How to Calculate Inventory
To calculate beginning inventory, start by determining the cost of goods sold (COGS). Then, add the value of the most recent ending inventory and subtract the total spent on new inventory purchases. The formula can be expressed as:
(COGS + Ending inventory) - Purchases
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With PackageX, you benefit from real-time inventory updates as orders are fulfilled and dispatched, so you get the most accurate information at your fingertips. Our comprehensive visual log shows you shipments moving in and out of your sites, helping you manage your inventory more effectively.
AI scanning technology digitizes logistics documents and automatically updates your inventory levels, eliminating the need for tedious data entry. Use your mobile phone for efficient receiving, inventory tracking, and fulfillment operations. Request a demo and learn how you can empower your team to work smarter, not harder.
FAQs
What is an example of a current assets inventory?
A good example would be unsold merchandise in a retail store, often called backstock. Since inventory is expected to be sold and turned into cash within a year, it’s classified as a current asset.
Is inventory always a current asset?
In most cases, inventory is classified as a current asset since it can usually be sold within a year. However, there are certain situations where inventory might be considered a long-term asset, such as when it takes longer to sell or liquidate.
Is merchandise inventory a current asset?
Merchandise inventory is a current asset on a retailer's balance sheet. Current assets are assets that will be used up or converted to cash within the next year. Merchandise inventory qualifies as a current asset because it is anticipated to be sold within the fiscal or calendar year.
