Inventories: what is it – Dictionary of Economics

Definition of stocks

They are the merchandise produced or purchased by the company that has not yet been sold.

Depending on the level of the production process, these can be:

– Finished products: their sale can be fast and immediate to the market.

– Products in progress: they are in the manufacturing process.

The product in progress is not like the finished product, it has no realization value, who would buy something half finished?

– Raw materials: they are the materials that will be used in the production process, it is unprocessed merchandise.

Its volume will depend on the ease of supply, variations in price, obsolescence, etc.

Regarding stocks, we must analyze:

– Is the level of stocks they record logical? Especially those completed in relation to the sales of the year, lest sales have stopped and Stocks are accumulating, because let’s not forget that a company manufactures merchandise to sell, not to accumulate Stock.

– Are there obsolete goods? Danger, they may be direct losses, since perhaps they cannot be sold and that part of the asset is overvalued, a provision for depreciation should be included.

– Are they correctly valued?

When analyzing stocks, the most important thing is to compare their reasonableness with sales of the finished product.

Normally the term of storage of goods will depend on the products, but it is estimated that the term of one month or two months is reasonable by sector.

If we multiply the number of inventories at the end of the year (or if we want we can calculate the average balance, taking the balance at the beginning and end of the year and divide it by two, thus obtaining the average balance), and multiply it by the number of months in which the company sells in a year (12 months), that figure should be similar to the sales for the year. If this is not the case, and the figure resulting from the multiplication is greater than the sales figure, the company is accumulating inventory for some reason.

Companies make or buy goods to sell to customers, not to keep in storage.

This incurs storage costs (even higher if the warehouse is not owned by you and you have to rent it).

Even more so, if the product is obsolete and can be damaged by not being able to sell it on time, for example: bread, fruit, etc.

But it can also be a strategy based on the knowledge that a rise in the value of stocks is expected in the market, and stocks are accumulated at the end of the year, and when the price has risen, they are sold.

In any case, allowing stocks to reach very high levels can cause excessive investment, a lack of liquidity if they are paid before they leave our warehouse for our customers, and if they are not sold, a further that probable risk of obsolescence.

The most logical reason that some companies have a high inventory rate is usually:

– Purchase of products in distant countries, in this case and given the need to make the purchase profitable and to ensure a minimum stock that ensures the next deliveries to its customers, large quantities of product are purchased so that it is profitable to buy from such a distance.

– The oscillations in the price of raw materials translates into the stockpiling in order to obtain an advantageous price, that is, a rebate per purchase, if I buy a certain volume it will be cheaper.

Our analysis will focus on the study of the following indicators:

– See percentage of stocks in the asset (in the calculation of percentages), in order to see how important stocks are within the asset.

– (STOCKS / PURCHASES) X 365, this ratio indicates the average number of days that stocks remain in our warehouse, for example: 20 days, 50 days etc., it will be interesting to compare these figures with those of the sector, in order to see if they stay longer than is normal in that sector or, on the contrary, they stay for less time, which will indicate an optimal rotation.

– PURCHASES / STOCKS will indicate the rotation in the warehouse of our stocks, for example 4 times, and we will know that there will be rotation in the warehouse every 90 days, or for example 12 times, and we will know that there is stock rotation every 30 days.

With the entry of the general accounting plan of 2007, the LIFO method (last entry first exit) is not allowed as a stock valuation system, the stock remains valued according to the value of the first that entered at the time, since those that first come out are the last ones that came in, reflecting a Stock value far removed from the current market value).

The market value of the stocks is reflected in a more exact way by the FIFO methods (first entry first exit, the first ones that entered leave the warehouse, and the last ones remain, the most current, those that best reflect the current value of the market ) and the weighted average cost method (arithmetic mean of the number of units and the value of each of them).

Example. Calculation of the average Stock Warehouse Period

A company reflects this data at the end of the year, and wants to know what the average period has been that the goods have been stored throughout the year.