In business, any item of property held in stock by a firm, including finished goods held for sale, goods in the process of production, raw materials, and goods that will be consumed in the process of producing goods to be sold. Inventories appear on a company’s balance sheet as an asset. Inventory turnover, which indicates the rate at which goods are converted into cash, is a key factor in appraising a firm’s financial condition. Fluctuation in the ratio of inventory to sales is known as inventory investment or disinvestment.
The money value of the inventory also appears on the income statement in determining the cost of the goods sold. The cost of goods sold is determined by adding the inventory on hand at the beginning of the period and the cost of purchasing and producing goods during the period and subtracting from this total the inventory on hand at the end of the period. For financial statements inventories are usually priced (1) at cost or (2) at cost or market value, whichever is lower. The cost of the merchandise and materials purchased usually fluctuates during the year, and it is necessary to determine which cost is to be used for inventory purposes. Three methods are in general use: average cost; first in-first out (FIFO), which assigns the cost of the last units purchased to the inventory and the cost of the first units purchased to the goods that were sold; and last in-first out (LIFO), in which the reverse pattern is followed.