Definition:

Inventories are assets held by a company for the purpose of selling in the ordinary course of business, being in the process of production for such sale, or being in the form of materials or supplies to be consumed in the production process or in the rendering of services.

Examples

Examples of inventories include raw materials, work-in-progress (WIP), and finished goods. For a car manufacturer, raw materials might include steel and rubber, WIP could be partially assembled vehicles, and finished goods would be completed cars ready for sale.

Formula:

There is no single formula for inventories, but inventory turnover can be calculated as:

Inventory Turnover = Cost of Goods Sold / Average Inventory

How to use the metric:

Inventories are used to assess a company's operational efficiency and liquidity. By analyzing inventory levels and turnover rates, businesses can determine how well they manage their stock and how quickly they can convert inventory into sales.

Limitations:

Inventories can be subject to obsolescence, spoilage, or theft, which can distort financial analysis. Additionally, different accounting methods (FIFO, LIFO, or weighted average) can affect the valuation of inventories and financial comparisons between companies.

Applies to:

Inventories are crucial in manufacturing, retail, and wholesale industries where physical goods are produced, stored, and sold.

Doesn't apply to:

Service-based industries, such as consulting or software development, typically do not maintain inventories as they do not sell physical goods. In these industries, the concept of inventory is less relevant.

Summary:

Inventories represent a key component of a company's current assets, reflecting the goods available for sale or production. They are vital for assessing operational efficiency but can be influenced by various factors, including accounting methods and industry type.