What is inventory?
Published
Inventory is goods held for sale, or materials that go into what is sold. It appears as a current asset on the balance sheet and converts into cost of sales the moment a sale occurs.
The equations
Inventory turnover = COGS ÷ Average inventoryAverage inventory = (Opening inventory + Closing inventory) ÷ 2Days inventory = Days in period ÷ TurnoverValuation rule:Inventory value = Lower of (cost, net realisable value)Net realisable value = Expected selling price − Expected costs to sell
Al-Waha's inventory in numbers
Average inventory = (118,400 + 141,200) ÷ 2 = SAR 129,800Turnover = 268,000 ÷ 129,800 = 2.06× per quarterDays inventory = 90 ÷ 2.06 = 43.7 days
How to read this: every riyal of stock converts into sales roughly twice a quarter. Goods sit 44 days in the warehouse before selling. Inventory rose SAR 22,800 during the quarter while sales grew by less - buying is running ahead of selling. That is the single largest reason Al-Waha's cash fell.
The right management question: if days inventory dropped from 44 to 30, the cash released would be roughly:
Daily COGS = 268,000 ÷ 90 = SAR 2,978Cash released = (44 − 30) × 2,978 = SAR 41,700
Stocktake variance and how to book it
The physical count on 30 June came to SAR 138,900, against a book balance of SAR 141,200.
Variance = 141,200 − 138,900 = SAR 2,300 shortfallAs % of inventory = 2,300 ÷ 141,200 = 1.6%
The correcting entry:
| Account | Debit | Credit |
|---|---|---|
| Inventory shrinkage (or cost of sales) | 2,300 | |
| Inventory | 2,300 |
The usual causes are damage, theft, receiving or issuing errors, or an unrecorded sale. A 1.6% variance is within normal range for retail and worth monitoring, but the same variance in the same direction every quarter points to a systematic warehouse problem rather than random error.
Lower of cost or net realisable value
An item costing SAR 50 whose market price has fallen, now selling at SAR 44 with SAR 3 of selling costs:
Net realisable value = 44 − 3 = SAR 41Cost = SAR 50Carrying value = SAR 41 (the lower)Write-down recognised = SAR 9 per unit
Inventory is never carried above what can be recovered from it. Businesses that hold slow-moving stock at original cost report assets above reality and meet the loss on liquidation.
Perpetual vs. periodic inventory
| Perpetual | Periodic | |
|---|---|---|
| Balance updated | On every sale or purchase | Only at physical count |
| Balance known | At any moment | At period end |
| Cost of sales | Posted with each sale | Calculated by formula at period end |
| Suited to | Any business running an accounting system | Very small businesses with few items |
A physical count is necessary under both. The system gives you the book balance; the count gives you the truth.
Frequently asked questions
Is inventory an asset or a burden?
Both. It is an asset on the balance sheet and locked-up cash in reality. Enough stock prevents stockouts; excess stock consumes liquidity and is exposed to damage and obsolescence.
How does inventory differ from a fixed asset?
Inventory is held for sale and becomes cost of sales. A fixed asset is held for use and becomes expense gradually through depreciation. The display shelf is a fixed asset; the goods on it are inventory.
How often should I run a physical count?
Annually at minimum, quarterly for high-value or fast-moving items. Monthly cycle counting on a rotating selection of items beats a single comprehensive year-end count.
Is VAT part of inventory cost?
Not if it is deductible - it goes to the input VAT account separately. Non-deductible VAT is capitalised into the item's cost.