In financial accounting, inventory is categorised as a current asset and operating asset as every business expects to encash it within its fiscal year. Inventories are liquid assets and goods of value that a company keeps and plans to sell for a profit. It helps to fund current needs. Correctly classifying asset classes is critical for a company’s solvency and associated risks to cope up with.
- In financial accounting, assets express the value of ownership that is convertible to Cash.
- These are the resources that a company owns or controls to run its business and generate a positive economic benefit.
- An asset can be a current asset, a fixed asset or noncurrent asset, physical asset, intangible asset (like patents), operating asset, and non-operating asset.
- Altogether, they build a company’s total assets.
- Convertibility, physical existence and usage are the pillars for the classification of assets.
Why is Asset Classification Required?
Let us elaborate on the importance of understanding asset classification in the competitive and high-risk scenario with examples.
- Current and fixed assets help to understand a company’s net-working capital.
- Tangible and intangible assets help to assess a company’s solvency conditions and the risk associated.
- Operating and non-operating assets make you determine the percentage of a company’s revenues from its core business activities. You can also determine the contribution of each asset to a company’s revenue.
- The current assets are short-term assets as they generally are sold for cash within one year.
- In other words, these are balance sheet items in either cash or cash equivalent or convertible into cash within one year.
- Current assets include cash and cash equivalents, inventories, office supplies, prepaid expenses, accounts receivable, short-term deposits, and marketable securities.
- These are the resources that fulfil a company’s operating needs to run its business and pay its current expenses.
- On the balance sheet a current asset gets listed at its market price.
- To calculate the current asset, use the following equation:
Current Assets = C + CE + I + AR + MS + PE + OLA
– C refers to Cash
– CE refers to Cash Equivalents.
– I refer to Inventory
– AR refers to Accounts Receivable. Click here to read in details about it.
– MS refers to Marketable Securities.
– PE refers to Prepaid Expenses.
– OLA refers to Other Liquid Assets
Is Inventory a current asset or Operating Asset?
- The inventory is an important current asset for businesses as it is more than just backstock. It includes raw materials, work-in-progress (unfinished products), merchandise, and finished goods that a company expects to sell quickly.
- Any valuable item used in the production of a good is also an inventory.
- Inventory is also categorised as an operating asset because it generates revenue from a company’s core business activities.
- Businesses intend to sell inventories within an accounting period or the next twelve months from the day they list their inventories/stocks on the balance sheet. Inventory liquidity depends on its demand in the market, seasonality, industry, and other factors.
- For a company, it is necessary to maintain a certain calculated level of inventory to run its business. It should neither be high nor low.
- Although inventory is less liquid than other short term investments, it is much more liquid than fixed assets like land and equipment.
- Inventories, unlike other current assets, are subject to revaluation in specific cases.
Is Inventory a Current Asset – Always?
Every company expects that its inventory will get sold off for a profit within its fiscal year. It is always treated as a current asset and listed on the balance sheet. However, if there is an excess inventory, it will be a liability for the company.
- It will be treated as a liability as the company has to bear its storage cost. Furthermore, if the inventory items are perishable with limited shelf life or become obsolete soon, they can lose their value in no time, for example, food products and technology.
- The company can sell off such excess inventory at a loss to avoid the storage cost.
Shortage of inventory
- Shortage of inventory can impact sales and disappoint customers.
- It affects the business’s reputation negatively. Therefore, still, it is a liability.
- Inventory control is the process to make available the right amount of supplies in a company.
- It is one of the main concerns of businesses dealing in large inventories to maximize profits by increasing customer satisfaction levels. With the practice of inventory control, a company ensures that it can meet customer demand.
- There is the requirement of data of purchases, reorders, freight, storage, receiving and much more for successful inventory control, which is hard to do manually.
- For a controlled inventory, companies establish asset accounts to balance the risks of inventory excesses and shortages. These accounts help track how much inventory a business has, the number and values of items available in stock, and the shelf life of each item. Click here to read about Top 6 Inventory Control Techniques.
Inventory Management System
Inventory Management is a broader term than Inventory Control. The inventory control manages the products already available in the warehouse. Whereas, inventory Management handles everything from getting items in the warehouse to reach the items at the final destination.
Thus, inventory management is the process of ordering, warehousing, and managing a company’s inventory that includes the management of raw materials, finished products, and processing such items.
An Effective Inventory Management System
A business requires an effective inventory management system for controlled tabs on the inventory. It helps to save money in the long run, saves time, and reduces waste. Read in details on how inventory management tools can help the manufacturing companies grow.
An inventory management system helps in:
- Supply chain management
- Warehouse management
- Integrating product coding
- Reorder reports
- Inventory lists
- Counts for selling or storing
- And many other processes.
Thus, a company can evaluate its current status concerning assets, inventories, account balances and financial statements using an effective management system.