Most businesses use a balance sheet to analyze their financial assets and liabilities at a specific time. And, when it comes to inventory, an inventory balance sheet reveals just how much cash your business has tied up on its shelves or in storage.
This article will define a balance sheet, reveal what’s listed on it, and note where inventory is on a balance sheet. Then, we’ll review how to analyze a balance sheet to assess inventory risk.
What is a balance sheet?
A balance sheet articulates a company’s assets and liabilities at a single, specific time. A balance sheet reveals a company’s worth at present, and in that sense, is a true snapshot of a business’s financial picture.
Your company’s accounting team, owners, executives, and other stakeholders will look to a balance sheet to determine whether the business is financially healthy.
What’s on a balance sheet?
A balance sheet articulates all your company’s assets and liabilities at a particular time, like the last day of the fiscal year.
If pieced together correctly, your most liquid assets should be at the very top of your balance sheet. Your team will get an even clearer picture of how much “cash” is available by listing assets in descending order of liquidity.
Your balance sheet may include details about:
1. Current assets
Current assets are anything your business owns that’s likely to be converted into cash within a year, including:
Cash, checks, or cash equivalents—such as money in your business checking or savings accounts
Inventory—including raw materials, works in process, and finished goods
Investments that can be easily sold within 12 months
Prepaid expenses—for example, if you pay your office rent, insurance, or internet bill annually ahead of time
Outstanding accounts receivable—if your invoice payment terms allow customers to pay later for goods or services, the money you’ll soon receive is still considered a current asset
2. Long-term assets
Unlike current assets, long-term assets will not be converted into cash within twelve months. Examples of long-term assets include:
Fixed assets, including real estate, physical buildings, computers, equipment, and machinery
Investments that cannot be easily sold within 12 months
If your business owes money, that’s considered a liability. Liabilities are also listed on your balance sheet and can be broken up into two categories: current and long-term liabilities.
Current liabilities refer to money you’ll need to pay out soon. This includes monthly or recurring expenses, such as payroll, interest, rent, utilities, and business taxes.
If your company owes money that’ll be paid over a long period of time, that’s a long-term liability. Long-term loans and deferred business income taxes are both long-term liabilities. And if your business has opted in to a pension fund, those liabilities are long-term, too.
4. Shareholders equity
Finally, shareholders’ equity will also be reflected on a balance sheet. Shareholders equity is the net worth of a company and can be calculated by subtracting the value of all liabilities from all assets.
What is inventory on a balance sheet?
On a balance sheet, inventory is a current asset that can be converted into cash within twelve months. But how do you determine the value of your inventory for a balance sheet?
Determining inventory value on a balance sheet
There are four types of inventory: raw materials, works in process, finished goods, and overhaul. And all of this inventory has a place on your balance sheet.
The first step is determining what inventory is genuinely a current asset. Remember, some items on your inventory list may be long-term assets, including machinery and equipment—like ultrasound machines or laptops. These long-term assets aren’t considered inventory on a balance sheet; they’re not intended to be converted into cash within a year.
Once you’ve determined what inventory is truly current asset inventory, you’ll need to find out how much you’ve got and how much it’s worth. There are many ways to do this, including by:
1. Using inventory management software
One way to quickly sort and evaluate inventory and assets? Using an inventory app like Sortly, tag each item in your inventory as “long-term asset” or “inventory”—then generate reports for each term.
As long as you’ve added item details into your software, you’ll instantly run a report that reveals how much of each item you’ve got, whether it’s a current or long-term asset, and its cash value.
2. Calculating ending inventory
Another way to determine the value of your inventory is by calculating ending inventory.
If you don’t have current inventory data on hand, you may need to halt your business and perform a physical inventory count. Perhaps consider uploading information to a perpetual inventory system as you perform your count. That way, in the future, it’ll be easier to get the data you need to evaluate your inventory whenever you wish.
Inventory should be near the top of your balance sheet since it’s likely one of your company’s most liquid assets. Whatever current asset is most easily converted into cash should be at the very top—and that’s almost certainly cash and cash equivalents themselves. So, where does inventory go on a balance sheet? Under current assets—perhaps second or third, and certainly before your long-term assets.
How to analyze inventory on a balance sheet
In general, a balance sheet can reveal your company’s financial health by weighing its assets against its liabilities. And by thoroughly analyzing inventory, your team can get a better idea of how liquid your inventory is and how efficiently your business uses or sells it.
In other words, by analyzing inventory on your balance sheet, your company can determine just how risky your inventory situation is.
Identify Inventory risks
Balance sheets can help your company identify financial risks, including shrinkage, spoilage, and obsolescence. Your balance sheet will not articulate inventory risks, so you’ll have to review your inventory reports with your team to determine risk.
Risk #1: Shrinkage
Inventory shrinkage means inventory has been shoplifted or stolen, a big concern for many retail stores. So if your company has tons of cash tied up in inventory, that’s a big risk—one that may justify a risk reduction strategy.
Risk #2: Spoilage
Inventory spoilage happens when inventory goes bad before a company can sell it. If your company makes or sells perishable items—like medicine or food—then too much inventory is a definite risk. While the cost of goods sold accounts for some spoilage, unusual or reckless spoilage is a big concern.
Risk #3: Obsolescence
Inventory obsolescence means your inventory has become dated, which slashes or completely decimates its value. This can happen when a product is timely or when new and improved versions of the product hit the market. Examples include Christmas sweaters, phone cases, and televisions.
Determine inventory turnover ratio
Determining your inventory turnover ratio can help you gauge your inventory risk, especially for spillage and obsolescence. Usually, the faster you turn over your inventory, the better. That’s because hanging onto inventory for too long increases the risk it’ll go bad or become outdated.
Remember, having an ultra-low inventory turnover ratio isn’t always practical. Instead, you’ll need to compare your turnover rate to that of your competitors, not businesses in totally different industries.
Calculate days inventory outstanding
Days inventory outstanding is a ratio that reveals how many days, on average, your company holds onto inventory before selling it to a customer. Again, compare your ratio to similar businesses and not across different industries.
Just like a high inventory turnover ratio is a concern, a too high days inventory outstanding calculation also indicates your business’s inventory is a high-risk asset.
How inventory software can save time and reduce risk
Inventory management software can help your company get organized and understand what it has on hand. But beyond that, the right inventory app can help your business automate and streamline tons of balance sheet-related inventory tasks, from keeping track of inventory levels to marking items as current assets (inventory) or long-term assets.
By having a real handle on what you’ve got, you’ll be able to easily calculate your inventory turnover ratio, see all your assets in one place, and make informed decisions about risk mitigation.
Sortly is a top-rated inventory app designed to help every business get organized—for good. Infinitely customizable and a cinch to use, Sortly can make even the most tedious of inventory tasks a breeze.
Ready to make analyzing inventory on your balance sheet that much easier? Start a Sortly trial—absolutely free for two weeks.
Lauren writes about inventory for Sortly. Her favorite thing to organize? Her comically large collection of stuffed animals.