Inventory is a valuable asset that small business owners need to monitor and manage effectively. These are the items you sell to customers that turn into cash you can use for operations or for the growth of your company. You need to implement a certain method in order to determine the value of inventory at the end of an accounting period.
Here are the different types of inventory management methods you can implement for your small business.
Weighted Average Cost Method
Businesses use this accounting inventory method when there are no substantial changes in their inventory. You get this number when you divide the cost of goods sold (COGS) with the total number of units. This method computes the average of inventory bought over a certain period. For example, if you manage to sell 200 of 400 products and your COGS is at US$900, the weighted average cost will be US$2.25 (900/400).
First-In, First-Out
One of the most widely used types of inventory management methods used by businesses is the First-In, First-Out method (FIFO). Companies of varying sizes use this because it is accurate even in times of seasonal fluctuations in demand. This approach assumes that you move the products bought first.
For example, company A purchased the following:
- 300 chairs in January for US$3
- 300 chairs in February for US$4
- 200 chairs in March for US$5
Company A has a total of 800 chairs and has managed to sell 500 of them during a certain period. The FIFO method assumes that you sold the oldest inventory first. For this example, you sold 300 chairs in January and another 200 in February. There’s 300 chairs left in your inventory from February to March. You get the value of the remaining inventory using the equation:
100×4 (the remaining inventory from February multiplied by its value) + 200×5 (inventory bought in March multiplied by its value) = US$1400
You compute for COGS using the equation:
300×3 (inventory bought first multiplied by its value) + 200×4 (inventory sold next multiplied by its value) = US$1700
Last-In, First-Out
In the last-in, first-out method (LIFO), businesses move the newest products first. This is the opposite of the FIFO method. Using the same example above, the outcomes of the value of inventory and COGS are different since the newest items are sold first.
- 300 chairs in January for US$3
- 300 chairs in February for US$4
- 200 chairs in March for US$5
You get the value of inventory with the equation:
300×3 (oldest and remaining inventory multiplied by its value) = US$900
You get the COGS with the equation:
200×5 (inventory sold first multiplied by its value) + 200×4 (inventory sold next multiplied by its value) = US$1800
As you can see, the amounts differed when you computed for the value of inventory and COGS using FIFO or LIFO.
These are three of the types of inventory management methods you might want to consider. Each has their own benefit when it comes to computing numbers for your financial statements. However, each also come with some disadvantages such as higher taxes or costs.
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