Inventory Revaluation Guide
We live in a VUCA (volatility, uncertainty, complexity, and ambiguity) world where changes in the exchange rate, supply chain disruptions, and transportation mishaps are commonplace. This makes the close tracking of inventory value critical.
Not only does improving inventory accuracy eliminate risks of financial surprises or taxation issues, but it also makes business decision-making easier.
With ShipBob’s inventory management solution, inventory revaluation becomes more smooth and results-driven than ever before.
In this article, we throw light on what inventory revaluation is, how it works, and its impact on a business’s balance sheet
So, what do you want to learn?
What is inventory revaluation?
Why is inventory revaluation crucial?
How inventory revaluation looks on your balance sheet
Inventory revaluation best practices & tips
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What is inventory revaluation?
Revaluation of inventory involves the tweaking of inventory costs to show the changes in the recorded unit cost. This can be done in the case of abnormal spoilage, exchange rate fluctuations, disrupted supply chains, obsolescence, or damage to inventory.
If you run an eCommerce business that deals in a lot of inventory, adopt inventory revaluation as part of the overall inventory management process.
Benefits unlocked by inventory revaluation include a better understanding of your profit/loss, compliance with regulations, and business decision-making.
How does inventory revaluation work?
Revaluation refers to a change in the carrying amount of assets. This process can lead to an increase or decrease in inventory value. Inventory needs to be recorded at the lowest of the two estimates: historic cost or net realizable value.
If there is no inventory price decrease or obsolescence or deterioration of inventory, account for inventories at the actual cost shown on the balance sheet.
But if these events occur, you must compare the historic cost of inventories (initially credited to the balance sheet on receipt of the goods) with the net realizable value of those inventories.
If the historic cost is greater than the net realizable value, it should be depreciated.
And, if the historic cost of inventories is less than the net realizable value, inventories can continue to be carried at historical cost.
To understand the working of inventory revaluation, here are a bunch of metrics to be mindful of:
- Cost of goods sold (COGS): COGS is usually included in the income statement. It showcases the value that your business had invested in inventory that was sold, within a certain period. The formula to calculate COGS is:
COGS = Beginning inventory + Purchases – Ending inventory
Based on this equation, if you wish to calculate the value of ending inventory, it would be:
Ending Inventory = Beginning inventory + Purchases – COGS
- Standard cost revaluation: When you update the fixed standard cost of products, based on changes in the inventory costs it’s called standard cost revaluation.
- Net realizable value (NRV): The NRV helps arrive at the expected selling price of all the products in the inventory. This metric shines a light on potential losses so that it becomes easier to prepare for or counter them.
NRV = Market value of the product – Product manufacturing and miscellaneous costs
A positive NPV indicates profits, while a negative NRV indicates losses. In the latter scenario, to decrease your inventory and net income, create a separate entry in your income statement called “loss on inventory.”
Accounting for your losses in your financial statements and balance sheets ensures that you do not overstate your inventory.
Why is inventory revaluation crucial?
Inventory revaluation is necessary to better manage better responses to supply chain breakdowns, product spoilage, product damage, and demand fluctuations.
- Supply chain breakdowns: The costs of inventory may shoot up in case of supply chain disruptions. You need to adjust the value of your inventory accordingly (adding the extra costs to the original price) so that you do not sell it at a loss.
For example, assume your computer shop’s supply chain has distributors in Country A.
If your primary distributor is not able to send the device owing to trade sanctions, it will take a much longer time to source it from another distributor in Country B. Here, you need to see if the cost of expediting the shipment (perhaps by air freight) is worthwhile, as compared to the sales opportunities lost when the product is out of stock.
And if it is a viable option, you need to factor the cost of air freight into the value of the inventory to ensure that your profit margins are not compromised.
- Product damage or obsolescence: When you order, transport, and store inventory, some of it is bound to get damaged or obsolete over time. Since these SKUs cannot be sold, you will have to secure the cost of these goods from the profits acquired from the rest of the sales.
For example, if you are selling cookie dough (with a shelf life of 6 months) on your eCommerce portal, there are chances that a few units are unsold even after the half-year mark. So, you need to revalue the remaining inventory revaluation to adjust for the losses.
- Demand fluctuations: Many times, you may stock a lot of inventory and be suddenly faced with a drop in demand. This would result in high carrying costs and blocked capital which can drive many retailers to bankruptcy.
To keep the inventory lean, you need to track demand forecasts and constantly carry out inventory revaluation.
Inventory revaluation and inventory accounting when done right can drastically improve financial accuracy.
More accurate inventory valuation can play a huge role in improving business strategy in the form of better inventory control and tax obligations management.
Here’s how inventory revaluation looks on your balance sheet
Revaluation can affect your finances, obligations, accounts, and balance sheet.
In the case of destroyed or missing goods, and assuming you have an inventory reserve, the revaluation of inventory will result in a write-down on the balance sheet.
On the other hand, it will affect the balance sheet and income statement if the revaluation is performed in response to a drop in the market value of goods.
Accounting errors or theft can lead to inventory shrinkage. And if your inventory reports do not reconcile with sales records you will struggle with accounting and tax miscalculations. This can cause the IRS to potentially audit your business.
To avoid this scenario, you need to constantly measure and track this metric using the following formula:
Inventory Shrinkage Rate = (Recorded Inventory – Actual Inventory) / Recorded Inventory
And if your inventory’s market value falls below the book value, but still retains some value, it’s called an inventory write down. In such cases, you need to record it as a write-down expense (depreciation) on a company’s balance sheet to reduce tax liability.
Revalue your inventory with these best practices & tips
Here are the steps to follow in inventory revaluation that can affect your eCommerce business’ consolidated EBITDA:
- Arrive at the purpose of the inventory revaluation. It could range from financial reporting, reducing tax implications, or regulatory compliance.
- Select the revaluation scope. In this step, you answer questions around the inventory items that must be included, the frequency of revaluation, and the degree of detailing required.
- Choose the relevant revaluation method. Typically, companies pick from these top inventory valuation methods that deliver higher inventory value:
- First-in, first-out (FIFO) method: Here, based on the assumption that the items purchased first are sold first, you assign value to the inventory. This affects the invoicing of your orders.
- Replacement cost method: The reassigning of inventory value is based on the current market price of the goods and not the original purchase price. You can compare the historical price of each unit stock with NRV to deduce the losses, if any.
- Implement the requisite processes and controls. To improve revaluation accuracy and efficiency, you must:
- Gate keep access to the inventory data
- Track and record all changes
- Investigate and resolve any discrepancies
- Maintain a reserve stockpile of products: In case of projected losses, due to broken, stolen, expired, or obsolete stock, you need to maintain reserve stock in your warehouse.
One of the commonly encountered challenges lies in correctly arriving at inventory costing. Securing the value of beginning and ending inventory is not simple, as the inventory periodically loses or gains value throughout its lifecycle. And this is difficult to keep track of.
The amount of inventory is also not easy to track with just physical inventory counts. This is why you need to follow a periodic inventory system or even better a perpetual inventory system.
Your inventory reserve also needs to be thoughtfully planned, else it can lead to blocked capital and excess stock that can become obsolete. Or, if the inventory reserved is too little, it can lead to stockouts.
Making mistakes in the inventory count or value can lead to fluctuations in profit margins at the end of the year. It can also adversely affect your business decisions related to purchase, budgeting, production, and pricing.
ShipBob’s inventory management solution prioritizes growth
Inventory revaluation can only be properly carried out by businesses with optimised inventory management operations. ShipBob’s industry-leading inventory management software ensures that businesses understand their inventory value and how it affects their growth potential.
Our inventory management software is included as part of their full-stack 3PL services. It syncs with ERPs to calculate your key metrics, see inventory levels, and even move inventory to different fulfilment centres with ShipBob’s automated inventory management software.
Click here to get a quote from ShipBob, for your business, for better inventory management.
Sort and distribute inventory across warehouses
Worried about sky-high logistics costs and in-efficient supply chains? ShipBob offers access to a wide network of fulfilment centres so that your inventory is distributed to the locations closest to the customer. Our warehouse, primed for local and international fulfilment of orders also optimises storage space and costs.
Enjoy real-time inventory status updates
ShipBob offers full inventory visibility from one single dashboard, no matter where your inventory is located. The data on this platform is updated constantly so you can track, view, and manage inventory levels in real-time.
Automate reorder points
Retailers have to place reorder requests to suppliers every time the inventory levels drop beyond a certain level. To know when to place their next order, the reorder point formula is often used. But manually doing this every time on Excel can be a struggle.
ShipBob forecasts demand and automates the inventory reorder process.
Watch as your orders are fulfilled
Once the customer places the order, ShipBob offers a transparent view of where SKUs are picked from, inventory transactions, and the latest status update of the goods in transit. We also support end-to-end order management with local and global shipping.
Prevent stockouts
When you do not account for sufficient reserve stock, it can result in lost sales and revenue. It will also result in disappointed customers. ShipBob runs accurate forecasts and tops up the inventory regularly so that stockout costs are always at an all-time low.
Inventory revaluation FAQs
Below are answers to common questions about inventory revelation.
How often should I revalue my inventory?
Revaluing inventory is a non-stop endeavor. Any market fluctuations, supply chain disruptions, or storage and transport mishaps can cause the inventory value to fluctuate. So you need to tie up with a 3PL that can simplify the tracking and management of the inventory revaluation on a regular basis.
What’s the impact of inventory revaluation on taxes?
The inventory revaluation can have a big impact on reported profit levels across fiscal years. And, if the profit margins are shown to be inflated, you are likely to have to pay a greater amount of income tax.
How can ShipBob aid in the inventory revaluation process?
ShipBob helps retailers track key metrics such as COGS, NRV, and shrinkage rate. We also offer access to historical and real-time inventory levels and prices so that inventory value of raw materials or finished goods can be revised.
