Market prices, exchange rates, supply chains, and production costs can shift instantly. For product businesses, especially SMBs without huge savings as a buffer, keeping up with these changes is critical to staying profitable and competitive.
But how do you make sure your inventory reflects these fluctuations accurately?
That’s where inventory revaluation comes into play. It allows you to adjust your inventory cost to accurately reflect current market conditions so you can maintain accurate financial statements, optimize tax benefits, and make informed business decisions.
We’ll explore inventory revaluation, how it works, why you need it, and its benefits for your business.
As mentioned, inventory revaluation (not to be confused with inventory valuation) means adjusting the book value of your stocked products to reflect the current market value.
This adjustment ensures a realistic view of your assets and liabilities in your financial statements. It also helps you better manage pricing, product choices, and future investments.
Imagine you’re a company that imports luxury speakers and sells them in the domestic market. After purchase, the market price of these speakers falls due to increased competition and anticipation of a newer model.
Originally bought at $500 each, the speakers are now worth only $300. You perform an inventory revaluation and reduce the book value of the speakers from $500 to $300 each to accurately represent the current value.
One of the key concepts in inventory revaluation is Net Realizable Value (NRV). When applied, it can help you better assess the true value of your inventory so you can make the necessary adjustments to your financial records. We’ll look at that later.
Standard cost inventory revaluation means adjusting your inventory value to match your calculated standard cost. Your standard cost is the combination of all costs to obtain your inventory and includes the original purchase price plus items like materials, labor, and overhead.
Adjusting your inventory value as the standard cost changes ensures your inventory records reflect up-to-date production and purchase costs. That, in turn, helps you maintain accurate financial statements and make better business decisions.
Let’s say you run a company that manufactures bicycles. Your initial standard cost for each bike is $200, based on materials, labor, and overhead costs. Over time, the price of steel increases, and your labor costs increase. As a result, the actual cost of producing each bicycle is now $220.
A standard cost inventory revaluation adjusts the value of your existing bicycle inventory from the old standard cost of $200 to the new actual cost of $220 in your financial statements, providing a more accurate picture of your business’s financial health.
Everyone would love to sell out of every product they buy for inventory, but that rarely happens. An inventory revaluation reserve (or simply inventory reserve) is an entry on your balance sheet for products you anticipate won’t sell because of obsolescence, spoilage, damage, or market demand changes.
An entry in this inventory account deducts the predicted inventory reserve to reflect a more accurate inventory value.
Here’s an example. You own a store that sells smartphones, and you purchase 100 phones at $300 each. A new model comes out while you still have 20 phones left.
You estimate you can only sell these last 20 phones for $200 each instead of $300. This means a potential loss of $100 each on those last 20 units, totaling $2,000.
To reflect this anticipated loss, you create an inventory reserve of $2,000 on your balance sheet and deduct it from your total inventory value:
NRV is the estimated selling price of products minus any costs you expect to incur before the sale. The expenses might include manufacturing, marketing, and distribution costs.
The NRV formula is:
NRV = Estimated selling price − cost of production − selling expenses
The parts of the formula are:
Suppose you own a bakery and want to calculate the NRV for 100 cupcakes. From your data, you know that:
Using the NRV formula:
You can reasonably expect to get $200 after selling 100 cupcakes.
Revaluing your inventory to reflect NRV can impact your balance sheet in two main ways:
Picture this: You own a bakery that specializes in gourmet cakes. You purchase 100 cakes for $30 each, totaling $3,000 in inventory. A new popular diet trend drops the demand for your cakes, and you can only sell them for $25 each, with advertising costs of $2 per cake.
In this case, you first need to calculate the NRV for the cakes:
Then, finalize the inventory revaluation:
Revaluing your inventory to reflect its NRV has lowered its value on the balance sheet by $700.
Here are three key reasons why you may need to revalue your inventory:
A break at any point in the supply chain can lead to long-term disruptions. In 2023, the unexpectedly low-yield Canadian canola crop led to supply issues for makers of salad dressings, coffee creamers, and breads.
Supply challenges included:
A disruption in your supply chain can significantly affect the availability and cost of your inventory. Inventory revaluation helps you navigate the supply chain breakdown without significant financial surprises. That way, your business remains resilient and responsive to market changes.
How? We’ll do a deep dive.
Let’s say you own a company that manufactures and sells specialty coffee blends. You rely on beans sourced from various international locations, but political unrest, like the mass protests in Peru in 2023, temporarily halts exports. This disruption means you can’t get your usual high-quality beans from that region, which are critical for your top-selling blend.
Fortunately, you find an alternative source from another country, but the beans are slightly more expensive, and the flavor is somewhat different. You decide to proceed with this alternative to keep your production running, but this change affects your final product’s cost.
In this case, you need to revalue your inventory to reflect these higher purchase costs. By doing so, you can adjust your pricing strategy to maintain profit margins. You can also decide whether or not to communicate these changes to customers, perhaps marketing the new blend as a limited edition to manage expectations.
Inventory items can be damaged or spoil over time, especially when dealing with perishable goods like food or fragile items like electronics. The reduced quality directly impacts the value of these products.
Inventory revaluation lets you adjust your stock’s recorded value downwards, aligning it with its current market worth. As a result, you get a realistic view of what your inventory is worth, which helps you make informed pricing decisions.
You might choose to offer damaged goods at a discounted rate instead of the full price, which can help you clear out the stock while still getting some revenue.
Revaluing your inventory also ensures you base your profit calculations on the actual value of goods sold, not inflated inventory figures. That way, you prevent surprises during financial audits and maintain credibility with lenders by presenting a transparent picture of your business’s financial health.
When consumer demand spikes or drops, the value of your inventory can change significantly. If a new trend pushes a product into the spotlight, its market value might increase. Likewise, if a product falls out of favor with consumers due to bad press, its value could decrease.
Lack of new funds from sales and the inventory carrying cost of unmoving stock can create a huge drain on company resources. Large supply chain events can worsen that situation.
The disruptions to stock over the pandemic and the 2021/2022 California port backups led to many companies facing excess stock. The combination of over-ordering and delayed stock finally arriving created a perfect storm of extra products.
That extra inventory plus increasing pressure from massive retailers like Amazon and Walmart, became too much for even larger companies and forced them to consider bankruptcy. Clothing giant Gap barely avoided bankruptcy in 2022 with $30.4 billion in inventory and the loss of its deal with Kanye West’s Yeezy line.
Inventory revaluation plays a large part in your company’s financial health. Let’s look at the primary ways it helps your business.
When you revalue your inventory, you adjust the recorded cost on your books to match the current market value of the items.
That adjustment directly impacts your income statement’s cost of goods sold (COGS), gross profit, and net income numbers. If the market value of the inventory has increased, reporting this higher value can boost your assets on the balance sheet, but value reductions drop your asset numbers.
An inventory management system like Cin7 seamlessly integrates with accounting tools like QuickBooks and Xero to ensure accurate and up-to-date financial records.
With accurate financial statements, you can make informed decisions about budgeting, investing, and strategizing for growth since you base your assessments on the true value of your resources.
Inventory revaluation ensures a smoother tax season. Whether the IRS requires you to do an inventory count at the end of the year or not, it’s a good idea to do an inventory count and revaluation.
An increase in inventory value can lead to a higher taxable income, as it may boost your profits on paper. On the other hand, if your inventory value goes down, you might report lower profits, which could reduce your tax liability for that period.
Cin7 Core’s integration with Avalara simplifies the complexity of tax compliance. You can manage inventory and order processing, plus conveniently calculate sales tax for any address within Cin7 Core.
Accurate inventory values help you forecast demand accurately.
If certain items grow in value consistently, you might increase your stock levels to meet potential future demand. In contrast, you may want to cut back on products that decrease in value to avoid overstocking items that could lead to losses.
Cin7’s acquisition of Inventoro makes the forecasting process even easier. With the addition of Inventoro’s proprietary AI engine, you can accurately forecast demand months in advance to maintain optimal stock levels and eliminate overages.
Regular revaluation helps you adjust your insurance coverage to better match actual stock value and avoid being over- or under-insured.
Inventory revaluation helps you maintain accuracy in your financial statements and adapt to market changes effectively.
With Cin7, you can track and manage your inventory and forecast demand accurately. That way, you’re well-prepared for future market changes and customer needs.
Schedule a free demo today to discover how Cin7 can help you effectively manage your inventory.
