What income statement account is linked to inventory on the balance sheet?
In the highly competitive market conditions enterprises are forced to increase their profitability. In this article we will review the impact of inventory on financial results of a company
1. Place of inventory in deriving at a company's profit (loss)
Inventory is defined as assets that are held for sale (i.e., finished goods), are in process of production for sale (i.e., work in process), or goods to be consumed during production (i.e., raw materials).
Inventory plays an important role in the assessment of a company profitability because inventory is a part of the cost of goods sold (COGS) computation:
COGS = Opening Inventory + Purchases (Cost of Production) - Closing Inventory |
For instance, Buddy Co (a fictitious entity) trades in fashionable clothes. At the beginning of the year it had goods in inventory valued at $6,000. During the year it purchased goods costing $50,000. Sales for the year amounted to $90,000. The cost of goods in inventory at the year-end was $12,500.
Sales |
90,000 |
|
Opening inventory |
8,000 |
|
Purchases |
50,000 |
|
Closing inventory |
(12,500) |
|
Cost of goods sold |
(45,500) |
|
Profit |
44,500 |
As we see, a major objective of accounting for inventories is the proper determination of income through matching costs with revenues.
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