Introduction
Knowing the amount of inventory on the balance sheet is vital for certain types of businesses to consider the health of the company. Holding inventory carries risks for the company. Some risks are inherent and certain, while there are some risks that can be planned for and managed. The risk worth considering when looking at companies and sectors to invest in is inventory that is outdated or spoiled. You would also want to know how much inventory the company loses due to theft or other losses.
Key Takeaways
The balance sheet will not explicitly state the risks associated with high inventory levels, but it will mention the value of the inventory the company holds. Holding a large amount of inventory for a product presents a risk as that product may become outdated. Consequently, the company may not be able to sell it. Spoilage occurs when a product decays and cannot be sold. This is a legitimate concern for companies that manufacture or distribute goods with a shelf life. Shrinkage occurs when inventory is stolen. The more inventory a company has on the balance sheet, the greater the chance of it being stolen.
Overview
The balance sheet will not show the risks associated with high inventory levels. Instead, it will only state the value of the inventory that the company owns. The information you need to find the risks can be found in the company’s annual report, footnotes to the financial statements, and other documents.
Inventory Risk #1: Spoilage
If a company has a lot of products on its balance sheet, it exposes that product to becoming outdated. Consequently, the company may not be able to sell the product or products. To make an outdated product appealing to buyers, its price must be significantly reduced as there may be newer and better products on the market.
Inventory Risk #2: Damage
Damage occurs when a product decays and cannot be sold. This is extremely important for companies that manufacture, assemble, and distribute perishable goods.
Inventory Risk #3: Shrinkage
When inventory is stolen or misappropriated, it is referred to as shrinkage. The more inventory a company has on the balance sheet, the greater the chance of it being stolen. This is why companies that have a lot of stock and public access to that stock are very good at mitigating risks.
Conclusion
Inventory on the balance sheet presents a unique problem. While increasing inventory is not always bad and depends on the industry, it creates risks that can harm the business if not managed properly. If these risks materialize, they can lead to losses that reduce shareholder returns and return on assets.
Source: https://www.thebalancemoney.com/inventory-on-the-balance-sheet-357281
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