Stock valuation: become a logistics expert with our 7 methods
As an inventory manager or entrepreneur, you are bound to go through an evaluation (or valuation) of your inventory in order to become aware of internal problems such as poor inventory management and to correct them quickly.
Better still, valuing your stocks allows you to optimise them and thus generate significant savings and a return on investment.
But of all the valuation methods used in accounting, which one is right for you?
Find out in our guide!
What is stock valuation?
Inventory valuation: definition
Inventory valuation is when you assign a conventional value to your inventories in the form of accounting calculations that are generally optimised according to your company's needs.
Inventory valuation takes place after the physical inventory of stocks and gives the exact amount of your company's stocks at a given date.
Stocks and work-in-progress are valued unit by unit or category by category. Different methods are used, depending on the type of product:
- stocks of raw materials, merchandise and supplies are valued at acquisition cost excluding VAT,
- work in progress is valued at the production cost incurred up to the inventory date.
Why carry out an inventory valuation?
Every year, not only do you have to carry out an inventory, which has to be audited by a statutory auditor, but you also have to carry out an accounting inventory, which shows the level of your stocks.
In this way, you and your team can implement precise strategies to correct poor logistics management and optimise your stock management.
Managing your stocks, evaluating them, correcting them and improving them is a guarantee of long-term performance. Don't neglect it!
The long-term benefits of valuing your stocks :
- target your objectives and achieve them quickly
- increase your returns,
- Beat your competitors on the market,
- save time,
- make savings,
- establish effective communication between the different agents in your company,
- know how long it will take to reduce your various types of inventory.
What are the different stock valuation methods?
The retail inventory method
Advantages:
- detects stock losses, damage and theft
- enables small businesses to keep track of the costs actually spent,
- keep a record of the goods you buy or sell
- keep the right amount of stock at all times,
- easy to calculate.
formula: cost price x 100 / retail price
Examples in figures:
You buy products for €40 and sell them for €70. Your cost/retail ratio is 57% ((40/70) x 100).
Your initial inventory costs you 2,000 euros, you make purchases of 3,000 euros and you sell products for a total of 5,000 euros.
Goods available for sale = starting inventory + purchases = 2000 + 3000 = 5000
The final stock result = Goods available for sale - sales (sales x cost/retail ratio) = 5000 - (5000x0.57) = 5000 - 2850 = 2150
Table examples:
| Initial inventory | Retail | |
| Start of inventory | 11 000 | 15 000 |
| Purchases (net) | + 69 000 | + 85 000 |
| Available assets and cost ratio | 80 000 | 100 000 |
| Retail sales | - 90 000 | |
| Estimated final retail stock | 10 000 | |
| Estimated closing inventory at cost | 8000 |
💡 Please note: this calculation method is generally not very accurate if prices vary over different periods or if your products have different margins .
The specific identification method
This method gives a specific cost for each item in your shop. Identify the location, cost and sale amount of each stock keeping unit (SKU) in your inventory beforehand for this method to be effective.
Advantages:
- Use this method if you have many different items purchased from several sources,
- better suited to small businesses
- provides information on stock deterioration and losses.
Calculation steps:
| A- Quantity purchased | 3000 |
| B- Units sold | 1000 |
| C- Balance | 2000 (A-B) |
| D- Price | 5,00 |
| Closing inventory | 10000 (CxD) |
| Cost of goods sold | 5000 (BxD) |
The First In First Out (FIFO) method
The First in First Out (FIFO) method estimates all sales of an item from the oldest batch in stock. Adopt this method if your purchase prices fluctuate.
💡 Please note: a batch is a set of products with the same price and the same age.
Advantages:
- optimal if your purchase prices fluctuate,
- very precise inventory,
- used for perishable products,
- allows you to remove old products from stock so that they do not deteriorate.
Formula: cost of oldest inventory x amount of inventory sold
Example of application:
You buy 4 chairs at €50 each and then 6 other chairs at €40.
The total value of the inventory is : 4x50 + 6x40 = 200 + 240 = 440
If you sell 3 chairs, you calculate the cost of goods sold (COGS) by deducting it from the oldest lot, i.e. 50 euros. This gives you: 3x50 = 150 euros.
The final inventory cost is obtained as follows: total inventory value - COGS = 440 - 150 = 290 euros.
The LIFO method (Last In, First Out)
This method of valuing inventories assumes that the company disposes of the most recently acquired assets first.
⚠️ The LIFO valuation method is prohibited in France by the International Financial Reporting Standards (IFRS), which establish and standardise accounting rules worldwide. This method is used mainly in the United States. So beware of its complexity if you want to use it.
The weighted average method
This method is useful when the price of your products varies little. You simply aggregate your costs for each storage unit.
Advantages:
- Simple, accurate calculation,
- practical when you have a lot of identical units.
Formula: (cost of opening inventory + purchases) - cost of goods sold
The weighted average unit cost (WACC) method at the end of the period
This is a widely used valuation method which consists of valuing inventories at the end of the period.
Formula: (initial stock value + receipt value) / (initial stock quantity + receipt quantity).
The weighted average unit cost (WACC) method at the beginning of the period
In contrast to the CUMP at the end of the period, the weighted average unit cost method after each period enables stocks to be valued after each receipt, therefore in real time.
💡 However, this method is rarely used, as it has the disadvantage of passing on changes in prices and costs.
Formula: (Initial stock value before entry + entry value) / (Initial stock quantity before entry + entry quantity)
The 4 risks of poor stock valuation to avoid
Stock-outs
A company that is out of stock leads to customer dissatisfaction and loss of sales, as customers may choose another product or even another brand.
Additional restocking costs
In order to replenish your shelves once you've received new goods, find out what you have in stock beforehand to avoid additional costs for orders that unfortunately don't sell out.
Supply chain slowdown
The supply chain is likely to slow down if you don't use stock valuation. As a reminder, it is preferable for your teams to coordinate and be aware of their stocks in order to better manage their workload and any underlying problems.
Surplus goods
Similarly, by anticipating replenishments thanks to your accounting calculations, you will be able to order the optimum quantity of products and thus avoid surplus stock. Your supply chain is considerably optimised.
So, which of these methods would best suit your stock management? Tell us in the comments!
Article translated from French