Inventory Management: FIFO, Perpetual Systems, and Stock Control

Posted on May 8, 2024 in Economy

FIFO Inventory Valuation

FIFO (First-In, First-Out) is a method for determining the cost of inventory. It assumes that the first items purchased are the first ones sold, regardless of actual physical movement. This method simplifies inventory costing and reduces the cost of goods sold when prices are rising.

Stock Cards and Perpetual Inventory

A stock card is a record that tracks individual inventory transactions. Perpetual inventory systems continuously update stock cards, providing real-time information on inventory levels and movements.

Benefits of Perpetual Inventory Systems

  1. Improved Accuracy: Detects stock losses and gains by comparing stock card balances with physical counts.
  2. Inventory Insights: Identifies fast and slow-moving items, aiding purchasing decisions.
  3. Efficient Reordering: Tracks stock levels and triggers reordering when levels are low.

Cost of Goods Sold (COGS)

COGS includes the purchase price of goods and any additional costs to prepare them for sale. It is calculated by adding the “OUT” column of stock cards.

Stock Turnover (STO)

STO measures the average number of days it takes to convert inventory into sales. A low STO indicates efficient inventory management. It is calculated as (Average Stock x 365) / COGS.

Improving STO

  • Increase sales.
  • Decrease inventory levels.

Inventory Management Techniques

  • Set Minimum and Maximum Stock Levels: Ensures sufficient inventory to meet demand while avoiding overstocking.
  • Stock Rotation: Sell older inventory first to prevent obsolescence.
  • Maintain an Appropriate Stock Mix: Adjust inventory based on sales performance.

Credit Transactions

Credit transactions involve delayed payment or receipt of cash. Invoices document these transactions.

Recording Credit Purchases

Credit purchases are recorded in the purchases journal and creditors’ subsidiary records.

Impact of Credit Sales

Credit sales increase revenue, GST liability, and debtors (accounts receivable). They also increase COGS and decrease inventory.

Inventory Valuation and Reporting

Physical stocktakes verify inventory records and ensure accuracy. The relevance principle dictates that only relevant information should be included in financial reports. Subsidiary records improve the reliability of financial statements.

Financial Statement Formats

Examples of financial statement formats are provided for the profit and loss statement, creditors’ balance, debtors’ balance, stock balance, and cost of goods sold calculation.

Debtors Turnover (DTO)

DTO measures the effectiveness of credit collection policies. It is calculated as Credit Sales / Average Accounts Receivable.

Managing Debtors

  • Offer discounts for early payment.
  • Conduct credit checks.

Creditors Turnover (CTO)

CTO measures how quickly a business pays its suppliers. It is influenced by credit terms offered by suppliers.

Consequences of Late Payments

  • Loss of discounts.
  • Interest charges.
  • Credit refusal.

Relationship Between DTO, STO, and CTO

These ratios are interconnected. Efficient inventory management (STO) and credit collection (DTO) improve the ability to pay suppliers (CTO).

Balance Day Adjustments (BDAs)

BDAs ensure that financial reports reflect the reporting period principle and provide relevant information for decision-making.

Accounting Concepts

Definitions of key accounting concepts such as assets, liabilities, revenue, and expenses are provided.