All businesses want to run smoothly, have happy customers who return to buy more of their products and, of course, turn a profit on a consistent basis. Having a steady flow of inventory is integral to helping achieve these goals.
To maintain a stock of products and to value a business for financial reporting and taxes, companies must calculate the inventory of the goods they have to sell. The good news is there is a software that businesses can use to help them manage inventory and revenue. Accounting software helps calculate how many products a company has in stock, track orders, balance budgets, maintain the list of goods and determine projected profits.
However, there is no one-size-fits-all approach to calculating product inventory; there are four: first in, first out (FIFO); last in, first out (LIFO); average cost; and specific identification.
Deciding which method to use depends on the type of goods a company sells and the preferences of their management team.
But, why does inventory matter?
Before digging into the four methods, let's unpack why a business needs to practice proper accounting methods and why accounting software is essential for managing inventory.
The inventory is the list of items to be sold by a business. Maintaining an accurate and complete assessment of products is essential for running a successful business. And, since the value of goods changes depending on manufacturing costs, demand for goods and the market, knowing what you have and how much it's worth is vital to achieving your business goals.
The goods or items sold can be standard or varied depending on the type of business. For example, if a business sells only shirts, they have a standard inventory of goods. If the company sells different types of products (shirts, pants and shoes) with different values, the products are varied.
For some companies, products, such as food, also have a shelf life. These products need to be sold in a particular order to protect them from spoiling. Both standard and varied items have different costs that affect the profit margin of the business.
What are differences in the accounting inventory costing methods?
To choose the proper inventory costing method, managers must know the differences among the four accounting types to better record and analyze the financial transactions of their business.
What is the end goal?
The goal of accounting and taking inventory is to ultimately determine the cost of goods sold, which is an inventory of the products a company has sold during a particular period like a month, quarter or year. Management calculates the cost of goods sold through proper accounting during their set time:
Beginning Inventory + Purchases of New Products = Available Products to Sell
Available Products to Sell – Ending Inventory = Cost of Goods Sold
When a business knows their expenses, which includes their inventory, operating costs, material costs and taxes, they can predict the company's revenue from sales of their products. By subtracting the company expenses from profits, they can determine the profit margin of the company as a percentage.
Companies using accounting software like NetSuite and inventory costing methods can better understand the health of their businesses, which, in turn allows them to better execute their business and marketing strategies.