How to Record and Analyze Inventory on a Balance Sheet

Last Updated June 28, 2024

A business balance sheet is one of the most essential financial documents your business can rely on to understand its financial health. By providing a snapshot of your current assets, liabilities, and owner equity, you can identify the line items that play a critical role in your bottom line.

One of the most important elements of learning about this document is understanding how to calculate inventory on a balance sheet. By properly recording and analyzing inventory on a balance sheet, you can identify common concerns such as inventory obsolescence, difficulty selling inventory, and more. A proactive approach toward inventory management is essential for effective working capital management.

Where Is Inventory Reported in the Financial Statements?

The balance sheet, cash flow statement, and profit and loss statement are considered the three major financial statements for any business. While all three financial statements are closely linked, there isn’t an inventory-specific financial statement. So, what financial statement is inventory on?

Inventory invariably appears in some form on all three statements. On a profit and loss statement, inventory comes into play when calculating goods sold to determine business revenue. You must calculate the total revenue from sold inventory, as well as the cost of goods sold.

Inventory also typically appears on cash flow statements, since it can affect cash inflows and outflows. Inflows stem from money your business received from sold inventory. Outflows could result from payments made to produce your goods or services.

Inventory goes on a balance sheet as well. As a business asset, inventory will appear under the assets category of this financial document.

Where Does Inventory Go on a Balance Sheet?

So, where is inventory on a balance sheet? Inventory is considered an asset because it is something that the business can sell to generate revenue. More specifically, it is considered a current asset because inventory is highly liquid—compared to other assets a business might own, it can be converted to cash relatively quickly.

Inventory classification on a balance sheet can be broken down even further, separating inventory into separate categories for raw materials, works in progress, and inventory that is ready to be sold. This can give business owners greater insight into their production processes and current inventory status—such as whether they may have a shortage or excess buildup of raw materials or finished inventory.

Another key question most businesses want to consider is how should inventory be valued on a balance sheet, or how can the value of inventory be determined? Generally speaking, inventory value is calculated by multiplying the number of items the company has in its possession by the items’ unit price. Inventory is valued using either the cost to the company or the market price—whichever is lower. This can be done on an item-by-item basis or by dividing inventory into major categories.

How to Analyze Inventory on a Balance Sheet

Once you know how to find inventory on a balance sheet, you must also consider how to record inventory on a balance sheet. While the inventory balance sheet represents a snapshot in time, it still requires careful calculation to ensure you can generate meaningful insights for your business.

Note the Beginning Inventory for the Period

There is no beginning inventory on a balance sheet since the balance sheet represents a single snapshot in time (usually at the end of the quarter or year). But to calculate your final inventory levels, you’ll want to start by noting the beginning inventory for the period.

Find the Ending Inventory for the Period

To determine the value of the closing inventory on the balance sheet, you’ll use the following formula:

Beginning Inventory + Net Purchases – COGS (Cost of Goods Sold) = Ending Inventory

The ending inventory on the balance sheet should include all raw materials, works in progress, and finished products that are yet to be sold.

With this in mind, can inventory be negative on the balance sheet? Technically, yes. However, this usually only occurs as the result of a transactional error or an issue with your production records. Correcting these issues is essential for keeping operations flowing smoothly.

Calculate Your Inventory Turnover Ratio

Once you have the ending/current inventory for the balance sheet, you’re ready to begin using this data to generate meaningful insights. Start by calculating your inventory turnover ratio by using this formula:

Inventory Turnover = COGS / Average Inventory Value

Inventory turnover measures how many times your company sold and replaced its inventory, relative to the cost of goods sold. Companies typically want a higher ratio because it indicates strong sales—though in some cases, it could also result from a company not having enough inventory.

Because the business balance sheet is produced at the end of a reporting period, the value of inventory included on the balance sheet is usually used for the average inventory value.

Calculate Your Days Inventory Outstanding

Days inventory outstanding (DIO) is another valuable metric that measures the average number of days your business held onto its inventory before selling it. It is calculated as follows:

DIO = (Average Inventory Value / COGS) x 365

A ratio that is higher than competitors in your industry indicates that your company is taking too long to sell its inventory and that your business might be at increased risk of excess inventory buildup. In the case of businesses that produce perishable goods, a high ratio could also indicate a greater risk for spoilage.

Compare Results with Inventory Turnover and DIO Figures From Previous Balance Sheets

Once you’ve used the data on your balance sheet to calculate inventory turnover and DIO, it’s essential that you then compare these results with the figures from previous balance sheets. Because a balance sheet represents a snapshot in time, it doesn’t reveal trends on its own.

To get the full picture, you should look at how these ratios compare to prior reporting periods. Are things getting better or worse? By looking at how ratios are changing over time, you can better determine if your inventory management processes are achieving desired outcomes or if you need to make strategic changes.

Create a Pro Forma Balance Sheet to Forecast Inventory

In light of the results of your inventory turnover and DIO analyses, figuring out how to project inventory on a balance sheet can play a key role in helping business owners determine which inventory management steps they should take.

This is where a forecasting inventory balance sheet—or a pro forma balance sheet—comes in. Like a standard balance sheet, the pro forma sheet evaluates assets, liabilities, and owner equity. With this document, however, you take a forward-facing approach, performing a scenario analysis based on different outcomes and assumptions associated with a strategic decision. This document draws on current numbers and informed assumptions for the future.

For inventory forecasting, a pro forma balance sheet could be useful in evaluating the potential financial impact of new product launches, liquidation efforts, obtaining inventory financing, and other actions that would directly impact inventory levels and value. It could also be used to predict long-term outcomes based on current inventory trends the business is experiencing.

By projecting potential outcomes associated with these future events, you can gain a clearer understanding of how inventory—and your company’s overall financial position—could change as a result of strategic actions. When used properly, this can help you refine your strategy to optimize inventory levels.

In-Summary: How to Record and Analyze Inventory on a Balance Sheet

By properly recording and analyzing inventory on a balance sheet, you gain essential metrics for measuring business success and optimizing your working capital. Going beyond the surface-level numbers and using current inventory data to calculate your turnover ratio and DIO can help uncover inefficiencies in inventory management practices.

While this information won’t solve problems on its own, by uncovering and strategically addressing inventory-related concerns, you can address key issues such as difficulty selling inventory and product spoilage to improve your working capital and streamline your inventory management.

FAQs

Does inventory go on the balance sheet?

Yes. Inventory is considered a current asset because it is a cash equivalent. As a result, it should be included in calculations for current assets.

What are inventories on a balance sheet?

Inventory on a balance sheet refers to the finished products (as well as the materials used to manufacture those products) that a company currently has in its possession.

Is inventory a current asset on a balance sheet?

Inventory is classified on a balance sheet as a current asset because it is a cash equivalent that can quickly be converted to cash. Once inventory is sold and paid for, it has been converted to cash.

What are the three types of inventory?

Many companies report three types of inventory on the balance sheet: raw materials, work-in-progress inventory (inventory that is currently being manufactured), and finished goods. Finished goods are the most liquid of these types of inventory, as they are ready to be sold to customers.

Can inventory be depreciated?

Business accounting practices don’t allow for depreciation or appreciation of inventory on a balance sheet because inventory is a current asset. Only fixed assets, which are meant to be owned for several years, can be depreciated.