Inventory costing is an accounting-based strategy for assigning value to your inventory. This is important for wholesale distributors as inventory costing helps ensure that your business is and remains profitable.
By assigning costs beyond just the purchase price, wholesale distributors can understand the entire value of an item. For example, it costs additional money to carry stock. Such costs need to be considered in order to ensure product margins are satisfactory.
3 Inventory Costing Methods
1. FIFO (First-In, First Out)
By far, the most popular method for inventory costing is FIFO (First In, First Out). This method assumes that the oldest items are sold and shipped first. This method is especially important for distributors that carry perishable items, or items with a short demand cycle, such as trendy or seasonal items.
For example, let’s say you purchased 100 purses for $15 each, but you later purchased another 200 for $18.50. Using FIFO, let’s assume that you sold all of the purses from the first order and 150 from the second order. To determine the value of your stock, multiply the remaining units that you haven’t sold (50) by $15, which equals $750. Therefore, the value of your remaining stock is $750.
2. LIFO (Last In, First Out)
The LIFO method assumes that the last items in are the first items out—exactly the opposite of FIFO, as mentioned above. Instead of valuing the items at the price when the first order was placed, items are valued by using the average unit price in the second, higher priced order (as used in the example above). Simply multiply the number of units remaining (50) by $18.50, which is $925, the remaining value of your stock remaining.
3. Weighted Average Cost
This method assumes that all goods receive the same valuation. For example, some items may be purchased at different costs. First, you need to calculate the average unit cost, which is the total cost of the items purchased divided by the number of units ordered. Then, multiply the average unit cost by the number of items sold combined with the number of unsold units and the resulting number is your weighted average cost.
For example, let’s assume that you purchased 300 purses. As in the earlier example, you purchased 100 purses for $15 each and 200 for $18.50. To calculate the weighted average cost, you need to multiply 100 by $15, which equals $1,500. Then, multiply 200 by $18.50, which equals $3,700. Now, add the two numbers together as such:
(100 X 15) + (200 X $18.50) = $5,200.
Divide $5,200 by the total number of units (300) = $17.33 (Average Unit Cost)
Multiply $17.33 by the remaining number of units (50) = $866.50 (Weighted Average Value of Stock)
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Categories: Inventory Management