Inventory is a collective term for raw materials, finished products, and products that are yet to be finished. In a balance sheet, inventory is an account that keeps track of all the above-mentioned items. It is considered to be one of the most important assets of a company as it is the major source of revenue creation.
Inventory is a current asset but it can't be easily converted into cash compared to other current assets. Consequently, it is excluded in the Quick ratio. Keeping inventory for long durations is not profitable because of the storage costs and potential damages.
Inventory is calculated using these methods:
- First in, First out: Considers that the oldest products are sold first
- Last in, First out: Considers that the latest products are sold first.
- Weighted-Average: Both COGS and inventory are valued based on the average cost of the products purchased during that period.