Inventory change definition
/What is an Inventory Change?
Inventory change is the difference between the inventory totals for the last reporting period and the current reporting period. The concept is used in calculating the cost of goods sold, and in the materials management department as the starting point for reviewing how well inventory is being managed. It is also used in budgeting to estimate future cash requirements. If a business only issues financial statements on an annual basis, then the calculation of the inventory change will span a one-year time period. More commonly, the inventory change is calculated over only one month or a quarter, which is indicative of the more normal frequency with which financial statements are issued.
Example of Inventory Change
As an example of inventory change, if the ending inventory at the end of February was $400,000 and the ending inventory at the end of March was $500,000, then the inventory change was +$100,000. This example could indicate a ramp-up in production to meet seasonal demand, or perhaps a decline in current demand that has resulted in more stock on hand than management had expected - it just depends on the circumstances.
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Where the Inventory Change Concept Applies
The inventory change calculation is applicable to the areas noted below.
Inventory Change in Accounting
Inventory change is part of the formula used to calculate the cost of goods sold for a reporting period. The full formula is:
Beginning inventory + Purchases - Ending inventory = Cost of goods sold
The inventory change figure can be substituted into this formula, so that the replacement formula is as follows:
Purchases + Inventory decrease - Inventory increase = Cost of goods sold
Thus, it can be used to slightly compress the calculation of the cost of goods sold.
Inventory Change in Inventory Management
The materials management staff uses the inventory change concept to determine how its purchasing and materials usage policies have altered the company's net investment in inventory. They typically drill down from the inventory change figure and review changes for each type of inventory (e.g., raw materials, work in process, and finished goods), and then drill down further to see where changes arose at the level of each stock keeping unit. The result of this analysis may include changes in ordering policies, the correction of faulty bills of material, and alterations to the production schedule.
Inventory Change in Budgeting
The budgeting staff estimates the inventory change in each future period. Doing so impacts the amount of cash needed in each of these periods, since a reduction in inventory generates cash for other purposes, while an increase in inventory will require the use of cash. This can be a major issue for a retailer, which needs to balance its cash reserves with the demands of its customers to keep more inventory on hand.
Inventory Change in Working Capital Analysis
The inventory change concept is also used in a general sense to keep track of the overall investment in inventory, which management may monitor to see if working capital levels are increasing at too rapid a pace. This is a particular concern in a rapidly-growing business, where management rarely has sufficient cash to fund the firm’s growth, and so monitors any changes in inventory on a regular basis, to keep from investing too much cash in this area.
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