4 Inventory Valuation Methods to Calculate Inventory Value
Regardless if you run a small business or a full-fledged ecommerce enterprise, inventory value will be a key ingredient in your brand’s long-term success. Not only does inventory value help your company maximize its profitability and create attainable revenue goals, but it can also improve the accuracy of your forecasting efforts, as well.
Keep reading to learn more about the ins and outs of inventory value—and to discover how to calculate this essential value all on your own.
What is inventory value?
Inventory value describes the monetary value of unsold merchandise at the time companies are preparing their balance sheets (or other financial statements). To put it another way, inventory value encompasses all the costs associated with your inventory at the end of an accounting period—whether that’s the end of a financial quarter or a full fiscal year.
So then, what is inventory valuation? Inventory valuation is the accounting process used to determine your brand’s inventory value. A good grasp on inventory valuation can help boost your profits and strengthen the accuracy of your reporting. While there are several different methods for valuation, FIFO and LIFO are among the most common.
Why is knowing your inventory value important?
Understanding your company’s inventory value is an important part of running an effective and efficient ecommerce brand. Aside from helping you establish necessary revenue goals, knowing your inventory value can also maximize profitability and inform your inventory forecasting.
Establishes revenue goals
If you don’t have established goals for your revenue, how will you know where your business is succeeding and where it’s falling short? Calculating inventory value is vital in creating financial goals and appraising your company’s current assets (including working capital).
Simply put, inventory value provides an opportunity to determine where your finances are best invested. In the same way, having a clear picture of your inventory’s worth will affect everything from your purchasing decisions to your marketing campaigns.
That’s why the value of the inventory is so integral to the health and wealth of your store—it not only guides your goal setting, but it ensures you’re on track to hit those targets, as well.
Along the same lines as reaching your revenue goals, inventory value does wonders for your brand’s profitability. That’s because the primary function of inventory value is to help you get a better idea of your financial position and current profit margins.
Inventory value directly impacts your total cost of goods sold (COGS), your gross income statement, and your reporting at the end of each accounting period. So in that way, inventory value can have a huge influence on the profitability of your company.
Once you know what your inventory is worth, you can decide whether you want to stay with your same manufacturers or suppliers, and whether you might need to increase or decrease your warehouse space. In addition, you can better determine pricing structures and how much you’re willing to spend on production (all of which can ramp up your cashflow in a big way).
Informs inventory forecasting
Because inventory value assesses your unsold inventory items, it can really help you navigate your forecasting projections. In order to forecast with any kind of accuracy, business owners need to know (1) what inventory they already have available, and (2) what range of budget they have to work with.
Inventory value provides insights into both qualifiers, meaning it lays the foundation for you to forecast with greater precision. What’s more, knowing your total value (ahead of creating demand forecasts) can also speed this process up—since you have a clearer vision of your inventory levels and what’s currently in stock at your warehouse.
Faster inventory forecasting translates to shorter lead times, which goes a long way in boosting customer satisfaction, as well.
4 inventory valuation methods
The most popular methods for inventory valuation include Last-in, First-out (LIFO), First-in, First-out (FIFO), weighted average cost (WAC), and specific identification—all of which are discussed in more detail below.
1. Last-in, First-out (LIFO)
Last-in, First-out (LIFO) is a valuation method where the products your company receives last have priority over any other inventory at your warehouse. In other words, retailers who use LIFO take the inventory they’ve received most recently and sell or ship those products first.
To calculate LIFO, you’ll first need to determine the cost of your beginning inventory (i.e. your most recent items), and then multiply that number by the amount of inventory you’ve sold.
LIFO = (cost of recent inventory x amount of inventory sold)
While the LIFO method excels at preventing perishable items from going bad, it’s not always the most reliable indicator of ending inventory value. When the last units you purchased are sold first, then your inventory valuation is based on the cost of your oldest units. Unfortunately, this will not be an accurate reflection of the current cost for said items.
With that in mind, the most likely reason why retailers use LIFO is to adapt during times of rising prices (like this period of inflation happening right now).
For example, when inflation increases the market value of your inventory, LIFO allows those higher costs to be reported on your tax return at the end of the year. As a result, you’ll increase your cost of goods sold while reducing your overall taxable income.
For that reason, some brands find LIFO beneficial because it can save on income tax and better match their revenue to the latest costs—even while prices are on an upward trajectory.
All in all, LIFO makes a good choice for merchants who have consistent shipping rates and who manage their inventory via automation. On the flip side, if you’re using an outdated order management system (OMS) or you experience a lot of staff turnover, then LIFO probably isn’t the best option for your brand.
2. First-in, First-out (FIFO)
First-in, First-out (FIFO) is essentially the exact opposite of the LIFO method. With FIFO, the first products your brand acquired are also the first items to be sold, used, or disposed of. More often than not, FIFO is the preferred way to keep inventory levels fresh—since your oldest stock takes priority over the newest items you’re bringing in.
To calculate FIFO, first determine the cost of your oldest inventory, and then multiply that number by the amount of inventory you’ve sold.
FIFO = (cost of oldest inventory x amount of inventory sold)
The FIFO method is an excellent indicator of your brand’s ending inventory value. Because your older products have already been sold and shipped out, it’s your newer products that are still hanging out on your warehouse shelves—and those are the SKUs that are apt to reflect the current cost. That is to say, they’re an accurate representation of the cost of goods available for sale (which is an amount needed to run through your inventory valuation).
Generally speaking, FIFO works great for ecommerce brands who are struggling to hit their KPIs despite being an established business. Conversely, the FIFO method likely won’t work as well if your business is just starting out and/or you don’t have much in your inventory quite yet.
3. Weighted average cost (WAC)
Weighted average cost (WAC) is a method for calculating the average cost of your inventory per unit. Finding your WAC is pretty straightforward—just divide your cost of goods available for sale by the total number of units currently in inventory.
weighted average cost = (cost of goods available for sale ÷ total units in inventory)
In many cases, weighted average is used in conjunction with FIFO or LIFO to create a more well-rounded valuation of your inventory. Still, WAC is perhaps best for situations when it’s too complicated to figure out what you paid for each unit in your inventory. That’s because it’s much easier to use the WAC formula to find the average value of goods rather than looking at each individual inventory item.
In addition, the average cost method can be super helpful as prices are fluctuating. In today’s market, prices for raw materials and finished goods are changing all the time—but these constant markups/markdowns make it difficult to know what you paid for an individual unit.
Luckily, WAC can simplify your inventory accounting and reveal the average cost of each SKU (which plays a big part in finding your ending inventory value).
Companies who can benefit from weighted average cost are those who order inventory on a regular basis and who experience a relatively fast inventory turnover. Even with a high level of reordering, WAC can easily be calculated since you aren’t tracking every single purchase or each individual purchase price.
4. Specific identification method
The specific identification method is used for tracking each individual product in your inventory—from its initial purchase to its final sale. More simply, specific identification assigns costs on an individual basis rather than grouping items together.
This inventory method is best utilized when a company is unable to identify each individual SKU in its greater product catalog. With that being said, specific identification is not recommended for companies with identical products sold in the thousands. However, brands who deal with high-value or one-of-a-kind items can definitely stand to benefit from this strategy.
For example, car dealerships, art galleries, and jewelry stores often utilize specific identification to inform their inventory valuation.
To effectively use this inventory management technique, retailers must be able to:
- Track individual SKUs separately via manual methods or RFID tags.
- Identify each individual SKU’s purchase cost and serial number.
If this information is known and accessible, then companies can measure the profitability of each item in their product catalog. Along with that, Specific ID provides the most accurate record of inventory costs and gross profits—which are foundational in calculating your total inventory value.
How Skubana helps you calculate your inventory value
This report reveals a snapshot of the total inventory value across all of your warehouses for a specific date.
If your brand needs help with calculating its inventory value, Skubana is at your service. In Skubana, inventory value refers to the dollar amount for each unit of a Master SKU—so this value will be recorded as the cost of goods sold once the order has shipped.
For Skubana users, inventory value will come from one of two places: Actual or Default IV.
Actual IV entries exist in the IV FIFO Queue. All entries are created by Skubana from either the Receiving Units via Purchase Order or the Reconciliation feature. If you click the Inventory Value History button (found under Stock Details), you can view the history for all Actual entries.
By contrast, Default IV entries are the values Skubana assigns when there’s no Actual IV entry to go off of (i.e. wherever a Discrepancy exists). Default IV is used solely for Analytics purposes and for the COGS amount recorded upon shipment.
As its name suggests, Default IV operates on a default basis. Skubana will refer to each option in this default order to determine inventory value. The default order is as follows:
- First-in, First-out (FIFO) Landed Cost value (for units received via Purchase Order) which creates Actual IV entries. In this scenario:
Note that the Item Landed Cost will incorporate any Aggregate Costs for the Purchase Order divided amongst the Total Units Ordered. Keep in mind that your Aggregate Costs do not include the automatically shown Item Cost amount, only any additional costs incurred.
- The Default Vendor Product's Cost can be found in the Vendor Product section. Skubana uses the top line quantity to calculate IV.
- If there’s no cost associated with the Vendor Product, then Skubana will look for a Vendor Cost within the product itself.
- If Skubana can’t find any of the above for the product, IV and COGS will be recorded as $0.
Once you’ve calculated your unique inventory value, Skubana can use these insights to help you create forecasting estimates and set up automations that fuel your growth. Skubana’s innovative inventory system can automate the full scope of your operations so that your brand enjoys a smooth data flow across all orders, inventory, and purchasing.
To get started with Skubana, simply request a free demo from our team today.
Frequently Asked Questions
Is inventory valued at cost or selling price?
Retail inventory is valued at cost, not by its selling price. These costs include the price to purchase items from a supplier plus any other expenses to get the inventory to the retailer. This logic follows the cost principle as it relates to inventory accounting.
Is stock valuation the same as inventory valuation?
Stock valuation is a method for determining the intrinsic value of said stock, which can reveal whether that stock is over- or undervalued at its current market price. Inventory valuation, on the other hand, is an accounting process used to calculate your brand’s inventory value. While there are several methods for inventory valuation, FIFO and LIFO are among the most common.
What is the formula for calculating inventory turnover?
Inventory turnover measures a product’s sales and replenishment over a set period of time. The formula for calculating inventory turnover is: (cost of goods sold ÷ average inventory for the period). The answer to this equation will reflect how fast a company sells through its stock, and is also used to gauge overall inventory efficiency.
Matthew Rickerby is the Director of Marketing at Extensiv, the leading solution for multichannel, multi-warehouse D2C brands. For the past ten years, he’s covered e-commerce topics ranging from SEO to supply chain management.