What is Inventory Change?

Inventory Change

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Inventory Change

Inventory change refers to the difference in a company’s inventory levels between two accounting periods. It’s a measure of how much the inventory has increased or decreased over a specified time frame.

Inventory changes can occur due to:

  • Sales: When a company sells its products, it will reduce the inventory.
  • Purchases: When a company buys more products for its inventory, it will increase the inventory.
  • Seasonal fluctuations: A company might increase inventory before a busy season and decrease it during a slow season.
  • Production: In a manufacturing company, production can increase inventory (with more finished goods being produced) or decrease it (with more raw materials being used).
  • Shrinkage: Inventory levels can decrease due to theft, damage, spoilage, or other losses.
  • Inventory write-offs: A company might reduce its inventory levels by writing off obsolete or unsalable items.

In financial accounting, the inventory change is taken into account in calculating the Cost of Goods Sold (COGS) and in determining the net income.

In the calculation of COGS, the formula is:

Beginning Inventory + Purchases – Ending Inventory = COGS

If the ending inventory is lower than the beginning inventory, there is a positive inventory change, indicating that more goods have been sold than purchased or produced in the period. Conversely, if the ending inventory is higher than the beginning inventory, there is a negative inventory change, indicating that more goods have been purchased or produced than sold.

Example of Inventory Change

Suppose you own a clothing store. At the start of the year (January 1), you have $100,000 worth of clothes in inventory.

During the year, you purchase an additional $200,000 worth of clothes to add to your inventory. By the end of the year (December 31), your inventory is worth $150,000.

To calculate the inventory change, you need to compare the value of your inventory at the end of the year to the value at the start of the year:

Inventory change = Ending Inventory – Beginning Inventory
= $150,000 – $100,000
= $50,000

So, you have an inventory increase (positive change) of $50,000 during the year.

This indicates that the purchases of clothes ($200,000) were greater than the amount of inventory sold ($150,000) during the year. This might be a sign that you are buying too much inventory, or it could mean that you are preparing for a busy period in the coming year.

In the context of calculating the Cost of Goods Sold (COGS), you would use the formula:

Beginning Inventory + Purchases – Ending Inventory = COGS
$100,000 + $200,000 – $150,000 = $150,000

So, your Cost of Goods Sold for the year would be $150,000.

These are simplified examples and in real business scenarios, other factors such as inventory shrinkage, obsolescence, or write-offs would also be considered.

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