How does effective inventory management affect the financial statements of a business as a whole?

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Michael Ugulini | (Level 3) Educator

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Effective inventory management contributes to the efficient and profitable operation of a business enterprise because significant monetary resources are typically tied up in inventory. It costs money to purchase inventory; it costs money to store and carry inventory in a warehouse or other environment.

As concerns a company's financial statements, inventory affects the totals reported on an enterprise's Balance Sheet, Cash Flow Statement, and Income Statement. For example, the value of inventory is included on the Balance Sheet under Current Assets. The cost of purchasing inventory that eventually sold is included on the Income Statement (or Profit and Loss Statement) as Cost of Goods Sold. Furthermore, cash outflows to suppliers for goods (inventory) are reported on the Cash Flow Statement under Operating Activities.

The value of inventory reported on the Balance Sheet for example affects the calculation of certain ratios. The inventory value that is a part of Current Assets affects the calculation of the Current Ratio, which is the proportion of current assets to current liabilities.

The Cost of Goods Sold (an inventory figure) reported on the Income Statement affects a company’s Gross Profit and Net Income.

Cash paid to suppliers for Inventory affects the Cash Flow Statement, which assists users of financial statements in determining the liquidity and solvency of a business.

Therefore, inventory and the management thereof, affects various financial statements that present a picture of an enterprise’s performance as a profitable or not-profitable entity.


Additional source: Fundamental Accounting Principles, Ninth Canadian Edition (Larson, Wild, Chiappetta, Nelson, Carroll, Zin) Chapter 7, p. 318.

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