Inventory valuation: become a logistics expert with our 7 methods
As an inventory manager or entrepreneur, you're bound to go through an inventory assessment (or valuation) in order to recognize and quickly correct internal problems such as poor inventory management.
Better still, valuing your inventory enables you to optimize it, and thus generate significant savings and a return on investment.
But of all the valuation methods used in accounting, which one is right for you?
Find out in our guide!
What is inventory valuation?
Inventory valuation: definition
Inventory valuation is when you assign a conventional value to your inventories in the form of accounting calculations, generally optimized to suit your company's needs.
Inventory valuation takes place after the physical inventory count, and gives the exact amount of your company's inventory at a given date .
Inventory and work-in-progress are valued on a unit-by-unit or category-by-category basis. Depending on the type of product, different methods are used:
- raw materials, merchandise and supplies are valued at acquisition cost, excluding VAT,
- work-in-progress is valued at the production cost incurred up to the inventory date.
Why carry out an inventory valuation?
Every year, you are required to carry out not only an inventory, which must be audited by a statutory auditor, but also an accounting inventory, which shows the level of your stocks.
In this way, you and your team can put in place precise strategies to correct logistical mismanagement and optimize your inventory management.
Managing your inventory, evaluating it, correcting it and improving it is the key to long-term performance. Don't neglect it!
The long-term benefits of inventory management:
- target your objectives and achieve them quickly,
- increase your returns,
- beat competitors to market,
- save time,
- save money,
- establish effective communication between the different agents in your company,
- find out how long it will take to reduce your various types of inventory.
What are the different inventory valuation methods?
The retail inventory method
Advantages:
- detects stock loss, damage and theft,
- enables small businesses to track actual costs spent,
- keep track of the goods you buy or sell,
- maintain the right amount of stock at all times,
- easy to calculate.
formula: cost price x 100 / retail price
Examples in figures:
You buy products at 40 euros and sell them for 70 euros. Your cost/retail ratio is 57% ((40/70) x 100).
Your initial inventory costs 2,000 euros, you make purchases of 3,000 euros and sell products for a total of 5,000 euros.
Goods available for sale = starting inventory + purchases = 2000 + 3000 = 5000
Final inventory result = Goods available for sale - sales (sales x cost/retail ratio) = 5000 - (5000x0.57) = 5000 - 2850 = 2150
Table examples:
| Initial inventory | Retail | |
| Start of inventory | 11 000 | 15 000 |
| Purchases (net) | + 69 000 | + 85 000 |
| Available assets and cost ratio | 80 000 | 100 000 |
| Retail sales | - 90 000 | |
| Estimated final retail inventory | 10 000 | |
| Estimated closing inventory at cost | 8000 |
💡 Please note: this calculation method is generally not very accurate if prices vary over different periods, or if your products have different margins .
The specific identification method
This method gives a specific cost for each item in your store. Identify the location, cost and sales amount of each SKU in your inventory beforehand, so that this method is effective.
Advantages:
- use this method if you have many different items purchased from several sources,
- better suited to small businesses,
- provides information on inventory deterioration and losses.
Calculation steps:
| A- Quantity purchased | 3000 |
| B- Units sold | 1000 |
| C- Balance | 2000 (A-B) |
| D- Price | 5,00 |
| Closing inventory | 10000 (CxD) |
| Cost of goods sold | 5000 (BxD) |
The First In First Out (FIFO) method
The First in First Out (FIFO) method estimates all sales of an item from the oldest batch in stock. Adopt this method if your purchase prices fluctuate.
💡 Please note: a batch is a set of products with the same price and age.
Advantages:
- optimal if your purchase prices fluctuate,
- very precise inventory,
- used for perishable products,
- allows you to take old products out of stock so they don't deteriorate.
Formula: cost of oldest inventory x amount of inventory sold
Application example:
You buy 4 chairs at 50 euros each, then 6 other chairs at 40 euros.
The total value of the inventory is : 4x50 + 6x40 = 200 + 240 = 440
If you sell 3 chairs, you calculate the cost of goods sold (COGS) by deducting it from the oldest lot, i.e. 50 euros. This gives you: 3x50 = 150 euros.
The final inventory cost is obtained as follows: total inventory value - COGS = 440 - 150 = 290 euros.
LIFO (Last In, First Out) method
This method of inventory valuation assumes that the company disposes of the most recently acquired assets first.
⚠️ The LIFO valuation method is prohibited in France by the International Financial Reporting Standards (IFRS) which establish and standardize accounting rules worldwide. This method is mainly used in the United States. So beware of its complexity if you want to get started.
The weighted average method
This method is useful when the price of your products varies little. You simply aggregate your costs for each storage unit.
Advantages:
- simple, precise calculation,
- practical when you have many identical units.
Formula: (cost of opening inventory + purchases) - cost of goods sold
The end-of-period weighted average unit cost (WAUC) method
This is a very common method of valuing inventories at the end of the period.
Formula: (initial stock value + receipt value) / (initial stock quantity + receipt quantity).
The weighted average unit cost (WACC) method at the beginning of the period
In contrast to the CUMP method at the end of the period, the weighted average unit cost method after each period enables inventories to be valued after each receipt, i.e. in real time.
💡 However, this method is rarely used, as it has the disadvantage of passing on changes in prices and costs.
Formula: (Value of initial stock before entry + value of entry) / (Quantity of initial stock before entry + quantity of entry)
The 4 risks to avoid from poor stock valuation
Out-of-stock situations
A company running out of stock leads to customer dissatisfaction and lost sales, as customers may choose another product or even another brand.
Additional restocking costs
In order to replenish your shelves after you've received new goods, make sure you know what you have in stock beforehand, to avoid additional costs for orders that unfortunately don't sell out.
Supply chain slowdown
The supply chain is likely to slow down if you don't use inventory valuation. As a reminder, it's best for your teams to coordinate and keep track of their inventories, so as to better manage their workloads and any underlying problems.
Surplus goods
Similarly, by anticipating replenishments thanks to your accounting calculations, you'll be able to order the optimum quantity of products and thus avoid overstocking. Your supply chain is considerably optimized.
So, which of these methods would best suit your inventory management? Tell us in the comments!
Article translated from French