Guide

What is inventory accounting and why do it?

Inventory is the biggest cost facing many businesses. See how good inventory accounting can help.

A worker stacking crates of fruit into a delivery van and doing inventory accounting

What is inventory?

Inventory are the items that your business has bought, with the intention of on-selling to customers. The items may be resold without change, or they could be combined into a new product.

What isn’t inventory?

Equipment and supplies you’ve bought to run your business, such as work tools, vehicles and stationery, typically aren’t treated as inventory. They’re recorded as expenses.

If you’re in ecommerce, and the goods you sell are supplied directly from a third-party to the customer, then you don’t have inventory either. You must own something for it to be inventory.

What is inventory accounting?

Inventory has a value – even before you do anything with it – and so it’s listed as an asset on your business balance sheet. But it can lose its value fast if it gets old, out of date, damaged, or the market price for that type of product drops. It also costs money to store.

Inventory accounting helps you figure out the value and costs of your inventory. That’s important for things like setting prices, getting insured, budgeting, working out taxes, and selling your business. It can also help you identify where you’re making the most money in your business.

Benefits of inventory management

Here’s how inventory accounting and management can help you both save money, and make money:

  • Maximising sales: Make sure you never run out of a product that people are buying
  • Lowering your bills: Reduce storage (and write-off) costs by ordering fewer of your slow-moving items
  • Getting you better deals: Learn what you should be ordering a lot of, and shop for bulk discounts
  • Showing where you make a profit: Properly tracking stock costs will tell you the true margin that products make you
  • Helping you do clever marketing: Identifying seasonal sales trends will help you plan promotions
  • Controlling tax bills: Timing of your order can affect your tax and when it’s due

Good inventory management will also help your cash flow. Instead of tying up money in slow-moving stock, you can keep it as cash and use it for more productive things like paying down debt or improving the business.

How to do inventory accounting

To understand your inventory, you need to know how much there is, what you’re spending on it, and how much you’re selling it for.

You can use rough estimates or get super specific in how you work this out. It all comes down to your inventory accounting methods, and the systems you put in place.

Learn more in our guide to Inventory.

Disclaimer

Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the provided content.

Download the guide to inventory

Learn the strategies and techniques behind successful inventory management. Fill out the form to receive our inventory guide as a PDF.

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