Is Inventory a Current Asset? Everything You Need to Know in 2023
In this article, we explore if inventory is a current asset based on its characteristics and several factors. Read on to learn more.
Is Inventory a Current Asset?
Inventory is considered a current asset as it consists of goods intended for sale within a year or the company's operating cycle. It is listed as a current asset on the balance sheet since it is expected to convert into cash or generate revenue shortly.
Example: The 200 smartphones in the inventory of a gadget retailer are classified as a current asset because they are expected to be sold within the next 12 months.
Why is Inventory a Current Asset?
Inventory is classified as current asset because it meets the criteria below:
Inventory is considered a current asset because it can be easily converted into cash within a short period typically within a year. Companies sell their inventory to generate revenue and improve cash flow and financial flexibility.
2. Business Operations
It plays a crucial role in the day-to-day operations of a business to ensure that products are available for sale to customers and contribute to revenue generation in the short term.
3. Financial Reporting
In financial reporting, inventory is listed as a current asset on the balance sheet as it reflects the company’s investment in goods that are intended to be sold in the near term.
The valuation of inventory affects the total current assets and overall financial position of a business. It is assessed regularly to ensure that the reported value is accurate.
5. Working Capital
Inventory is a component of working capital that is essential for financing short-term operational needs. An adequate level of inventory ensures that a business can cover its operational expenses and invest in opportunities for growth.
Is Inventory Always Classified as a Current Asset?
Inventory is typically classified as a current asset because it is expected to be sold, used, or turned into cash within one year or one operating cycle. However, there can be exceptions where inventory might not be considered a current asset. Let’s explore these exceptions below.
1. Long Production Cycles:
For industries like aircraft or shipbuilding with long production cycles, converting inventory to finished goods and selling them might take over a year. In such cases, part of the inventory can sometimes be classified as non-current.
Example: A shipbuilding company is constructing a specialized ocean liner. Due to the complexity and scale of the project, it is expected to take three years to complete before it is ready for sale.
2. Specialized Products:
When dealing with highly specialized products that have a limited buyer base or are made to order, the selling process can extend beyond a year.
Example: A company that manufactures custom, luxury automobiles may take more than a year to assemble, finish, and deliver each vehicle to individual buyers. This is due to the intricate detailing and bespoke features requested.
3. Regulatory or Legal Restrictions:
There could be regulatory or legal restrictions on the sale of certain types of inventory causing them to be held for more than a year before they can be sold.
Example: A pharmaceutical company has developed a new drug, but must wait for FDA approval before it can sell the product. The approval process can extend well beyond a year which causes the inventory to be held for an extended period.
4. Seasonal Inventory:
In some cases, goods that are highly seasonal may not be sold within a year if they miss the season. However, this is more of a business operation issue rather than a classification issue.
Example: A clothing retailer overestimated the demand for their winter collection. After the season ended, they had to store the excess inventory until the next winter. This means those goods weren’t sold within the typical annual sales cycle.
Here are some examples of inventory classified as current assets:
1. Raw Materials Inventory:
These are the basic materials and components that are to be used in the manufacturing process to produce finished goods.
Examples: Steel for car manufacturing, fabric for clothing production, ingredients for food processing
2. Work-in-Progress (WIP) Inventory:
This inventory includes goods that are partially completed and still in the production process.
Examples: A half-assembled bicycle, partially stitched garments, incomplete furniture
3. Finished Goods Inventory:
These are the completed products that are ready for sale.
Examples: Cars in a dealership, packaged food in a warehouse, clothing in a retail store
4. Merchandise Inventory:
For retail businesses, this inventory includes goods bought from suppliers that are ready to be sold to customers without further processing.
Examples: Electronics in a store, books in a bookstore, groceries in a supermarket
5. MRO (Maintenance, Repair, and Operations) Inventory:
These are supplies used in the production process but are not part of the final product. They are essential for maintaining the business’s production capacity.
Examples: Cleaning supplies for machinery, tools and equipment for maintenance, and safety gear for workers
6. Consignment Inventory:
These are goods that are still owned by the supplier but are held by the retailer. The retailer pays for the goods only when they are sold.
Examples: Jewelry on consignment, art pieces in a gallery, books in a consignment bookstore
We hope that you now have a better understanding that while inventory is typically considered a current asset, there are exceptions.