What Are Inventorial Costs?
Inventories are the goods that a company has on hand to sell. These costs can include raw materials, supplies, parts, and finished goods. As inventories are held by the business they become inventoriable costs. The cost of these items is recorded as an asset on the balance sheet until it is sold to another entity. When this occurs, the cost of the inventory is moved to the cost of goods sold or COGS.
How Do You Account For Inventoriable Costs?
Inventoriable costs are the costs incurred to gather the inventory held by a business. These include costs such as manufacturing costs, shipping costs, and other similar expenses. Businesses use a specific process to account for these types of expenses. The company needs to record each cost specifically for each item that is being sold from inventory. It can be done by recording it at the time of purchase or production. It can also be recorded when it is shipped, delivered, or received into their facility. The main reason for this process is to keep track of what costs are related to which products. This allows accounting personnel to appropriately allocate the costs to each product sold throughout the company’s fiscal year.
Why Is It Important To Know What These Costs Are?
As mentioned previously, inventoriable costs are the costs spent to get the inventory in the business. This includes costs such as labor, shipping, building space, and anything else used to acquire or produce products for sale. The reason it is important to know what these costs are is that different types of companies can use these numbers differently. What they are used for is based on the business model that the company uses. What they are looking at can be payroll costs, administrative costs, or anything else related to producing products. Basically, what companies use these numbers for varies between businesses and can change with time.
How Does This Affect The Company’s Income Statement And Cash Flow Statement?
The amount of the inventoriable costs in a company’s income statement affect both the gross profit and operating incomes. More expensive products with high costs per good will be less than products that are selling for cheaper prices with less cost per unit. This relates directly to how much money is left over after deducting the inventory costs from sales revenue. The amount of inventoriable costs in a company’s cash flow statement affects the amount of available cash. What is left over after deducting the inventory costs from sales revenue will be put towards other needs for the company. This can include purchasing more materials, marketing to drive up future sales, expanding current facilities, or it could even be put towards paying down debt. What it is spent on can vary between businesses and will depend largely on the type of company that is being analyzed.
What Is an Inventory Turnover Ratio Formula?
Inventory Turnover Ratio Formula is a business ratio that measures how many times a company’s inventory has been sold and replaced during a certain time period.
When Would You Use An Inventory Turnover Ratio Formula?
An inventory turnover ratio formula may be used to determine how long the average customer is taking to purchase an item from a business’s inventory and how frequently inventory is purchased. The formula may be used to determine the speed of customer turnover in a retail store, for example, or it can measure how much money should be spent on purchasing new inventory if the rate of return is too low. What this means is that customers are not picking up items at a fast enough pace so other items may need to be purchased in order to keep the store well-stocked.
What Types of Inventoriable Costs Can You Use?
There are two types of inventoriable costs you can use:
Period Costs are costs of purchasing an item before it is even begun to be processed. This includes the cost of acquiring materials, labor, equipment, and space for manufacturing or processing. For example, if you have a business that packages groceries, then your period costs may include all the grocery boxes, tape to seal the boxes, the dry ice used to keep groceries fresh, and/or any other items needed before products are put into grocery boxes.
Product Costs are costs incurred during production of a good. This would include raw materials, labor to produce goods, equipment for creating finished products, etc. For example if you have a business that manufactures furniture, then your product costs may include lumber for support beams, nails or screws used to connect pieces of wood together, fabric used to make the couch cushions, and/or paint used to finish up the frame.
Examples of What Can Be Inventoriable Costs
There can be many examples of inventoriable costs. Take note that what is used as an inventoriable cost will depend on the type of company, what they are selling, and their business model. Some examples of this can be:
- Raw materials
- Plant equipment
- Administrative expenses
- Shipping costs
- Store space
- Rent equipment
- Labor costs
- Marketing costs
- Research and development costs
- Manufacturing supplies
- Insurance premiums
As mentioned, all of these types of costs can vary with time depending on your business and what is needed. What you use for your company may change with time so it’s important to stay up-to-date when using these types of costs in the business.
The Bottom Line
Inventory costs are one of the main set of bookkeeping costs for a business. What inventoriable costs are shows how money is being spent throughout the different stages of production of an item, which can affect many things in a company’s financial statements including their revenue, expenses, and cash flow statements. They can also be used to determine how much money to spend on inventory for your company and how long the average customer is taking to purchase items. What types of inventoriable costs can be used, examples of what can be used as inventoriable costs, and when you should use these types of costs are all important pieces of information to know if you want to learn more about using these types of costs in your business.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.