Inventory Accounting: Why You Can’t Afford To Ignore It

by Tanya April 14, 2023

Inventory accounting (also called inventory management) is the process of controlling and tracking raw materials, work-in-progress, and finished goods. It aims to maximise sales and minimise costs by assessing the precise value of assets at different stages of their manufacturing and production.

Accurate inventory projections are crucial for maximising profits and keeping your business afloat.

However, it’s not an easy process for new business owners to master.

The basics of inventory accounting

Inventory accounting is a crucial business function that can impact your cash flow, cost of goods sold, and profit margins.

Inventory accounting involves tracking and valuing inventory at different stages of production, from raw materials to finished goods that are ready for sale.

Inventories are defined by AS 2 – “Valuation of Inventories” and Ind AS 2 – “Valuation of Inventory Components.” They exist in three distinct categories: raw goods, work-in-progress products, and finished goods.

The inventory process typically allocates a value to each item at different stages of production and records them as company assets. Accurately noting asset values ensures a precise representation of the company’s overall financial picture.

Establishing market values and prices

Inventory is a valuable asset for any business, and it’s important to establish accurate market values. Understanding the value of your inventory can help you make more profitable purchases, sell more products, and keep your financial statements accurate.

Several inventory valuation methods are available for your business, including First-In, First-Out (FIFO) and Last-In, First-Out (LIFO). These methods have a direct impact on the cost of goods sold, net income, and ending inventory.

While both FIFO and LIFO can be applied to any inventory, choosing the right method for your specific circumstances can have a significant effect on your profit margin. For example, if your inventory costs are escalating or likely to increase, using the LIFO method will result in higher costs and lower profits than the FIFO method.

In contrast, if your inventory costs are falling, the FIFO method will have less impact on your profit margin as the earliest items you purchase are the ones that sell first. Therefore, it’s best to choose the inventory valuation method that reflects your periodic income accurately and suits your business situation.

Inventory is one of the largest assets your business owns. Accurately valuing this asset can affect your business’s gross profit and income statement, as well as its ability to attract investors.

Leveraging technology to streamline your processes

Streamlining your processes can be a powerful way to boost efficiency and enhance customer service.

For example, if you have a business that ships products, onboards new employees, sells virtual technology, or treats medical patients, you may be able to improve the speed and accuracy of your operations by implementing the right technologies.

A cloud-based inventory management solution enables you to view your inventory across multiple warehouses and from any internet-connected device, including smartphones. It also allows you to streamline your physical stock takes with barcode scanning technology.

The best part is that these technologies can also help you save money in the long run, reducing the number of times your staff has to re-enter data and enabling them to focus on more value-added tasks.

There are many ways that technology can enhance the inventory management process, from better inventory visibility to more efficient ordering, replenishment, and fulfillment. The key to success is identifying the right solution for your specific needs and integrating it into your workflow with minimal disruption to productivity. 

Once you’ve chosen the best fit for your needs, you can start reaping the benefits of improved efficiency and enhanced service to your customers.

Strategies for managing reorder levels

Inventory is a vital part of any business, and managing your stock well can help ensure that you are meeting customer expectations. In addition, it can save you money and protect your cash flow.

One of the best ways to manage your inventory is by setting a reorder point. This allows you to order enough stock when it is needed, without overstocking. It also prevents you from losing sales or customers due to stockouts.

Reorder points can vary based on the item or product you are trying to manage, but they are typically calculated based on a combination of factors such as average daily sales and lead time. Using these numbers will allow you to set a reorder point that is likely to be the most effective for your specific needs.

Use several other strategies for managing your stock, including cycle counts and spot checks. These techniques can help you identify and remedy small inaccuracies, which will be critical for boosting your bottom line.

Tax implications for inventory accounting

The tax implications of inventory accounting are a consideration that must be taken into account.

However, a business owner should not become overly fixated on the effect of inventory on taxes. Instead, they should consider how inventory is used throughout the entire company and make sure it is well-planned and optimized for the business’s goals and growth objectives.

Inventory management can be an extremely time-consuming task, especially for small-to-mid-sized companies with multiple locations and online marketplaces. These firms may find it difficult to keep track of their inventory and manage it for tax purposes without the assistance of a professional who specializes in this area.

One way to minimize the tax impact of inventory is by minimizing the amount of unsalable or unused inventory in your warehouse or storefront. This can be done through inventory write-downs, which eliminate the cost of goods sold (COGS) on unsold items.

Another method of reducing inventory is by using the last-in, first-out (LIFO) inventory method. This method allows a company to use the inventory costs from the most recent sales as the basis for determining the cost of goods sold.

Utilizing the last-in, first-out inventory method can reduce a company’s cost of goods sold and increase its net income. The FIFO method of inventory management is also beneficial to small businesses because it can help them avoid having waste products that cannot be sold or are below their original purchase value.


Inventory isn’t just something you buy and put on your shelves – it’s an asset, and you need to treat it as such. Keeping track of on-hand stock is an important part of any business, and it requires proper accounting practices to ensure that your financial statements show accurate and consistent data.

Once you have a firm understanding of the basics of inventory accounting, it’s time to start thinking about your specific business needs and goals. Depending on your industry and production processes, you may need to set up complex accounting procedures for your company’s inventory management system.

The first step is to create a chart of accounts, which will help you keep track of your assets and liabilities. Your assets include anything of value that you own, including cash, accounts receivable (customers owe you), and inventory.

Using these assets to your advantage will help you achieve better business results. For example, you can decide to expand your high-profit products and discontinue low-profit or minimally profitable ones. This is known as the Pareto principle, and it is a common strategy that helps you focus your resources on items that produce the highest return on investment.

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The first Millennial blogger in the UK. Twitter @_luckyattitude

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