In this article, we will explore inventory roll forward and its importance for your business. We will cover our step-by-step inventory roll-forward process and apply it to an example.
An inventory roll forward is an accounting method that tracks changes in a company's inventory quantity and value from one accounting period to the next. It helps businesses calculate the ending inventory balance, and cost of goods sold (COGS), and prepare financial statements.
Example: In January, a car dealership began with 100 vehicles valued at $2 million. They purchased 50 more for $1 million and sold 30 vehicles during the month. Using inventory roll forward, they calculated an ending inventory of 120 vehicles valued at $2.1 million.
The inventory roll-forward process is important for several reasons in business and financial management. Let’s explore some of these below.
Inventory is a significant asset for many businesses and its value affects the balance sheet and income statement. By performing an inventory roll forward, companies can provide accurate information on inventory levels and help stakeholders understand the financial performance of the organization.
The ending inventory balance calculated through the roll forward is essential for calculating the cost of goods sold (COGS). COGS is a critical expense item on the income statement, and it directly impacts a company's profitability.
Many tax authorities require businesses to report their inventory levels and related costs accurately. Inventory roll forwards help companies comply with tax regulations and calculate taxes owed based on inventory values.
Understanding changes in inventory levels over time can help businesses optimize their inventory management processes. It allows them to identify trends, seasonal fluctuations, and potential issues such as excess inventory or stockouts to enable better inventory control and cost management.
Accurate inventory data from roll forwards is crucial for effective financial planning and budgeting. It helps businesses make informed decisions regarding inventory purchases, production schedules, and pricing strategies.
Transparent and accurate reporting of inventory levels enhances investor and stakeholder confidence in a company's financial statements. It provides assurance that the company's assets and liabilities are accurately represented.
Maintaining accurate records of inventory through roll forwards can help mitigate risks associated with inventory fraud, theft, or discrepancies. It provides a mechanism for internal controls and audits.
The formula for calculating the ending inventory balance in an inventory roll forward can be expressed as follows:
Ending Inventory = Beginning Inventory + Additions - Deductions
Where:
Inventory Roll Forward is a valuable tool for businesses to maintain accurate records of their inventory levels. Here's how our inventory roll-forward process typically works:
In this initial step, the company determines the quantity and value of inventory items it possesses at the beginning of the accounting period. This starting point sets the foundation for the inventory roll-forward process.
Example: At the start of the year, Tech Electronics assesses its beginning inventory, which consists of 1,500 smartphones valued at $300 each, totaling $450,000.
During this phase, the company accounts for any increases in inventory during the accounting period. These additions can result from new purchases, production, or any other means of acquiring inventory.
Example: Throughout the first quarter, Tech Electronics acquires an additional 500 smartphones at a cost of $320 each, contributing $160,000 to their inventory.
This step involves tracking reductions in inventory, typically due to sales or other deductions like damaged or obsolete items. The cost associated with these deductions is factored into the calculation.
Example: In the first quarter, Tech Electronics sells 300 smartphones, each with a cost of $300, resulting in a deduction of $90,000 from their inventory value.
With the data from the previous steps, the company calculates the ending inventory balance. This represents the value and quantity of inventory on hand at the end of the accounting period.
Example: After assessing additions and deductions, Tech Electronics calculates their ending inventory for the first quarter to be 1,700 smartphones with a total value of $520,000.
The ending inventory balance is crucial for calculating the Cost of Goods Sold (COGS), which is a key expense on the income statement. It helps determine the cost incurred to produce or purchase the goods sold during the period.
Example: By subtracting the ending inventory value of $520,000 from the beginning inventory and additions ($450,000 + $160,000), Tech Electronics calculates a COGS of $90,000 for the first quarter.
The final step involves using the calculated ending inventory and COGS figures for financial reporting purposes. These numbers are used in income statements and balance sheets to assess the company's financial performance and asset values.
Example: Tech Electronics incorporates the ending inventory value of $520,000 and COGS of $90,000 into their financial statements for the first quarter, helping stakeholders understand their financial health and performance.
Fashion Emporium wants to accurately assess its inventory levels, calculate the cost of goods sold (COGS), and provide stakeholders with a clear picture of its financial performance. Let’s explore how they implement our inventory roll-forward process:
Fashion Emporium starts the month of April with a beginning inventory of 1,000 men's suits valued at $200 each and 800 evening gowns valued at $400 each, totaling $200,000 (1,000 suits * $200) + $320,000 (800 gowns * $400).
During April, Fashion Emporium purchases an additional 400 men's suits at $250 each, contributing $100,000 to their inventory, and 300 evening gowns at $450 each, adding $135,000 to their inventory.
In April, Fashion Emporium sells 300 men's suits and 200 evening gowns, each with a cost as calculated above, resulting in deductions of $60,000 (300 suits * $200) + $80,000 (200 gowns * $400) from their inventory value.
After assessing additions and deductions, Fashion Emporium calculates their ending inventory for April. For men's suits, they have 1,100 remaining (1,000 beginning inventory + 400 additions - 300 deductions), and for evening gowns, they have 900 remaining (800 beginning inventory + 300 additions - 200 deductions).
The ending inventory value is calculated as follows:
By subtracting the ending inventory value from the beginning inventory and additions for both men's suits and evening gowns:
Fashion Emporium calculates a COGS of $80,000 for men's suits and $95,000 for evening gowns for the month of April.
In this final step, Fashion Emporium utilizes the calculated ending inventory values and COGS figures for financial reporting purposes. These numbers play a pivotal role in their financial statements, helping stakeholders gain insight into the company's financial performance and asset values.
We hope that you now have a better understanding of inventory roll-forward, its importance, and how to implement the process for the accurate financial reporting of your business.
If you enjoyed this article, you might also like our article on inventory discrepancy or figure out if inventory is a current or noncurrent asset.
