Is Inventory a Current Asset?

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Is Inventories a Current Asset?

Inventory is the asset held for sale in normal routine operations; therefore, inventory is considered a current asset because the company intends to process and sell the inventory within twelve months from the reporting date or, more precisely, within the next accounting year.

Inventory is the goods used to produce finished items and acts as a buffer between the manufacturing of goods and the goods the Company has to sell to fulfill the orders. Since inventory is used to manufacture goods that generate revenue for the Company, it is classified as an asset.

But whether inventory is a current asset or a non-current asset?

  • Current assets can convert into cash or cash equivalents in a short period, usually taken as one year. In contrast, non-current assets take longer than one year to be converted into cash.
  • Inventory is considered to be sold off within one year. However, a lot depends on the business opportunities and market conditions; however, it is considered that the inventory on the Company's balance sheet is sold off in less than one year and, hence, recorded as a current asset.
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Inventory Current Assets Example

As can be seen in the below snapshot from the consolidated balance sheet of Apple Inc., the inventory is recorded as the Current asset.

balance sheet of Apple Inc

Source: Apple SEC Filings

  • Inventories are believed to be sold within one year for all possible reasons. Hence, they are recorded as current assets. However, sometimes the Company does not receive expected orders, and therefore they cannot use the inventory. Such unused inventory may become a liability for the Company as it will incur storage costs and other related costs to maintain the inventory for it to be useful.
  • Some inventories, for example, Agriculture resources, have a shelf life. After a certain time, the inventory becomes stale and obsolete and cannot be used for further manufacture. Such shelf life is usually less than one year more, making it recorded as a current asset. The Company will have to dispose of such inventory if it is not used within the shelf-life period, thus incurring losses. Therefore, the Company cannot maintain a massive inventory due to storage costs and shelf life.
  • Companies have to maintain adequate supplies so as not to disrupt their business. If the Company holds less inventory than is required, it may lose business opportunities. The Company will not be able to fulfill the orders on time and hence lose revenue and reputation.
  • Companies invest a lot to maintain a good inventory management system. They ensure that they have sufficient inventory in the stores not to disrupt their business and that it is used not to cost them storage or waste.

Importance

  • Inventory is used to manufacture the goods. The raw materials inventory used in the production also represents inventory, without which the Company cannot produce its goods.
  • The current assets on the Balance sheet of the Company record the amount of such inventory available with the Company. These also include any finished goods available with the Company which is not yet sold.
  • The most important financial ratio related to inventory is the inventory turnover ratio, which measures the company's inventory management effectiveness.
  • It is calculated as Sales/Inventory and provides an insight into how many times the company sells off its inventory.
  • Days to inventory turnover is another crucial financial ratio tracked by investors and analysts. It is calculated as 365/Inventory turnover and denotes the number of days the Company takes to replace its inventory through sales.

Conclusion

Inventory is the goods or raw materials available with the Company, used for the production of the final goods. Since it is used in the production of assets sold by the Company, which is the primary source of operating income, they are considered an asset for the Company. Inventory is considered to be sold in less than one year and hence, is recorded as a current asset. It is believed that the Companies manage their inventory properly. It is too low that its business gets disrupted and not to keep too high inventory such that it incurs storage cost or loss due to damage and wastage.