Is Inventory a Current Asset?

Is Inventories a Current Asset?

Inventory is the asset that is held for sale in the normal routine operations, therefore, inventory is considered to be a current asset because the intention of the company is to process and sell the inventory within twelve months from the reporting date or more precisely within next accounting year.

Inventory is the goods used for the production of finished items and acts as a buffer between the manufacturing of goods and the goods the Company has to sell to fulfill the orders. Since inventory is used to manufacture goods which generate revenue for the Company, it is classified as an asset.

But whether inventory is a current asset or a non-current asset?

  • Current assets are the assets that can be converted into cash or cash equivalents in a short period, usually taken as one year. In contrast, non-current assets are the assets that take time longer than 1 year to be converted into cash.
  • Inventory is considered to be sold off within one year. However, a lot depends on the business opportunities, market conditions; however, it is considered that the inventory on the balance sheet of the Company be sold off in less than 1 year and hence, recorded as a current asset.

 

Inventory Current Assets Example

As can be seen in the below snapshot from the consolidated balance sheet of Apple Inc., the inventory is recorded as the Current asset.

balance sheet of Apple Inc

Source: Apple SEC Filings

  • For all possible reasons, Inventories are believed to be sold within 1 year. Hence, they are recorded as current assets. However, sometimes the Company does not receive expected orders, and therefore they could not use the inventory. Such unused inventory may become a liability for the Company as it will incur storage costs and other related costs to maintain the inventory for it to be useful.
  • Some inventories, for example, Agriculture resources, have a shelf life. After a certain amount of time, the inventory becomes stale and obsolete and could not be used for further manufacture. Such shelf life is usually less than one year more, so making it be recorded as a current asset. The Company will have to dispose of off such inventory if it is not used within the shelf-life period, thus incurring losses. Therefore, the Company cannot maintain a massive inventory due to storage cost and shelf life.
  • Companies have to maintain adequate supplies so as not to disrupt their business. If the Company holds less inventory than is required, it may lose on business opportunities. The Company will not be able to fulfill the orders on time and hence lose revenue and reputation.
  • Companies invest a lot to maintain a good inventory management system. They ensure that they have sufficient inventory in the stores so as not to disrupt their business and also that it is used such that it does not cost them storage or wastage.

Importance

  • Inventory is used to manufacture the goods. The raw materials inventory used in the production also represents inventory, without which the Company cannot produce its goods.
  • The current assets on the Balance sheet of the Company record the amount of such inventory available with the Company. These also include any finished goods available with the Company, which is not yet sold.
  • The most important financial ratio related to inventory is the inventory turnover ratio, which measures the effectiveness of the inventory management of the Company.
  • It is calculated as Sales/Inventory and provides an insight on how many times the company sells off its inventory.
  • Days to inventory turnover is another crucial financial ratio tracked by investors and analysts, which is calculated as 365/Inventory turnover and denotes the number of days taken by the Company to replace their inventory through sales.

Conclusion

Inventory is the goods or raw materials available with the Company, which is used for the production of the final goods. Since it is used in the production of assets sold by the Company, which is the primary source of operating income, they are considered to be an asset for the Company. Inventory is considered to be sold in less than 1 year and hence, is recorded as a current asset. It is believed that the Companies manage their inventory properly such that it too low that its business gets disrupted and not to keep too high inventory such that it incurs storage cost or loss due to damage and wastage.

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