Inventory is a critical component of many small businesses in India. Whether you are a retailer, manufacturer, or distributor, inventory is likely to be one of your most significant assets. As such, accounting for inventory is a crucial aspect of financial management for small businesses in India.
According to a report by the Federation of Indian Micro and Small & Medium Enterprises (FISME) and the Ministry of Micro, Small and Medium Enterprises (MSMEs) titled “Digital MSME Scheme: Awareness, Challenges, and Benefits,” inventory management is one of the critical challenges faced by small and medium-sized enterprises (SMEs) in India. The report highlights that inventory management is crucial for SMEs, as it directly impacts their profitability and competitiveness.
While inventory accounting can be complex, it’s a critical aspect of financial management for small businesses. By using the right tools and choosing the right valuation method, you can ensure that your inventory is an asset to your business and not a liability.
In this article, Finsmart Accounting – trusted globally for outsourced bookkeeping services in India – cover the basics of accounting for inventory & its impact in small businesses in India:
Basics of Inventory Accounting
There are two primary methods for valuing inventory in India – First-In, First-Out (FIFO) and Weighted Average Cost (WAC).
- FIFO assumes that the first inventory purchased is the first inventory sold. This means that the cost of the oldest inventory is used to calculate the cost of goods sold (COGS). FIFO is a popular method for valuing inventory because it tends to result in a more accurate representation of the cost of goods sold.
- WAC, on the other hand, calculates the average cost of all inventory items purchased during a specific period. This average cost is then used to calculate the COGS. WAC is a more straightforward method than FIFO but can result in less accurate COGS calculations.
Small businesses in India should choose the valuation method that best suits their inventory needs and business goals. If your business deals with perishable or fast-moving inventory, FIFO may be the best option. However, if your business deals with slow-moving inventory or if you want a simpler method, WAC may be a better choice.
Once you’ve chosen a valuation method, the next step is to track inventory movements. This means recording when inventory is purchased, sold, or used in production. You’ll also need to record any adjustments made to inventory, such as for spoilage or obsolescence.
Tracking inventory movements can be a time-consuming task, but it’s essential for maintaining accurate accounting records. You can use a manual system or an inventory management software solution to track inventory movements.
Read on to discover more about accounting for inventory. Also, check out outsourced payroll services in India
Using your chosen valuation method, you’ll need to calculate the cost of your inventory on hand. This will give you an accurate picture of the value of your inventory and the cost of goods sold.
For FIFO, you’ll need to use the cost of the oldest inventory to calculate the COGS. For WAC, you’ll need to calculate the average cost of all inventory items purchased during a specific period.
Calculating inventory costs can be complex, especially for small businesses with a lot of inventory. However, using inventory management software can simplify the process and reduce the risk of errors.
Finally, you’ll need to prepare regular inventory reports, such as an inventory valuation report and a cost of goods sold report. These reports will help you make informed business decisions and track your financial performance.
Inventory valuation reports show the value of your inventory on hand, while cost of goods sold reports show the cost of goods sold during a specific period. By comparing these reports to your sales and revenue data, you can get a better understanding of your profitability and make adjustments to your business strategy if necessary.
Learn why Kailash Maisekar, Managing Director at Idox India, recommends Finsmart Accounting for accounting outsourcing services in India
Impact of Inventory Accounting
In the context of small businesses in India, inventory accounting can have significant impacts on various areas of the business. We would like to highlight below impact on your accounting:
Accurate inventory accounting is essential for financial reporting. The value of inventory on hand can significantly impact a company’s balance sheet, and incorrect inventory valuations can lead to inaccurate financial statements. Accurate inventory accounting can also impact the cost of goods sold, which can significantly impact a company’s profitability. Inaccurate cost of goods sold calculations can result in under- or over-stated expenses, which can lead to inaccurate profit and loss statements.
Inventory accounting can also impact taxation. In India, small businesses are required to pay Goods and Services Tax (GST) on their sales, and the cost of goods sold is an essential component of this calculation. If the cost of goods sold is incorrectly calculated, small businesses may end up overpaying or underpaying GST, leading to potential penalties or lost revenue.
Inventory accounting can impact cash flow, especially for small businesses. Maintaining an adequate inventory level is crucial for ensuring that the business has sufficient inventory to meet customer demand while minimizing inventory holding costs. However, holding too much inventory can lead to cash flow issues, as the business has tied up its cash in inventory. Accurate inventory accounting can help small businesses optimize their inventory levels and improve their cash flow.
Accurate inventory accounting is also essential for production planning. Knowing the amount of inventory on hand can help businesses determine when they need to reorder supplies or raw materials. It can also help them determine the optimal production schedule to meet customer demand while minimizing production costs.
Supply Chain Management
Inventory accounting can impact supply chain management. Accurate inventory accounting can help businesses identify which items are selling well and which items are not, enabling them to adjust their supply chain accordingly. It can also help businesses identify potential inventory shortages, enabling them to take action to mitigate the risk of stockouts.
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Shalaka Joshi is the founder of Finsmart Accounting and operates in the capacity of Director. A Chartered Accountant passionate about outsourcing and problem-solving, Shalaka has more than 20 years of experience in the field of accounting, payroll and MIS reports.