Stock valuation is a crucial part of doing business and this not an overstatement. If not done properly, stock valuation can affect a business’ ability to meet objectives, and may result in serious consequences for the business. Another reason to perform stock valuation such retail stocktaking and food & beverage stocktaking is fulfilling legal obligations.
Businesses are required by law to ensure the full disclosure of their stocks, including their ‘true number’ and value. Stock valuation has a role to play in the authenticity of your financial statements.
What Makes Stock Valuation Important for Businesses?
Since the reported stock amount will affect the COGS, gross profit and net income on the P&L statement and the current assets amount including total assets, working capital and the owner’s equity on the balance sheet, having an accurate valuation of stock is critical. In short, incorrect stock valuation will result in two incorrect financial statements, which can have deep-lying consequences for any business.
A practice that is underemphasized in the small to mid-size business world, stock valuation is crucial to ensure accurate measurement of stocks—a current asset, which in turn can help produce meaningful financial statements and enable informed business decision making. Stock valuation is crucial for your business, but don’t choose the stocktaking method for your business blindly. Instead, make the choice after much deliberation and foresight. Remember, how you choose to perform stocktaking will have an effect on your strategic planning, taxes and profitability.
Reversing course can be difficult once you have an established method for stock valuation. So, think about your stocktaking options carefully and pick a method that helps you to best meet your business objectives. With stock valuation, you can consolidate the costs of purchasing, managing and distributing stock. Make sure that the stock valuation method you choose is influenced by your business environment because daily stock management varies in terms of value, complexity and volume.
The Acceptable Stock Valuation Methods
Specific-identification
A method that tracks a specific cost associated with a specific stock from start to finish, specific-identification tags each stock with a specific cost as it enters the system and that cost remains associated with the stock until the stock is relieved. A method that looks simple on paper, specific-identification is the hardest to practice as it involves the use of project codes, lot numbers or serial numbers to track stock in detail. Due to this requirement of the method, specific-identification is a stock valuation method used mostly by high value businesses with low stock volume that experience high volatility in stock costs.
FIFO (First-In First-Out)
You’ve probably read a lot about FIFO (First-in First-Out) in the accounting class at school or college and have a fair idea of what it represents in the business world. A stock valuation method that tracks stock by layers, FIFO involves stacks of stock/inventory with varying costs. In the FIFO method, the addition to stock occurs at the top of the stack and stock is grabbed from bottom of the stack whenever there is a need to pull it. So, the cost of your oldest stock is the one that is selected when stock is pulled using the FIFO method.
Since the stock you have will generally carry more value than the stock you sell, FIFO leans more heavily towards your balance sheet when there is an upward trend in costs. Accounting for obsolescence is another reason for employing this stock valuation method.
LIFO (Last-In First-Out)
As the name suggests, Last-In First-Out or LIFO is the opposite of First-In First-Out (FIFO). Just like FIFO, LIFO involves stacks of stock/inventory, only this time the stock is both added to and pulled from the top. So, the cost of your oldest stock is the last one selected when stock is pulled using LIFO method.
Since relieving inventory will give you the most recent value of stock, LIFO means more heavily towards your P&L when there is an upward trend in costs. Since costs generally increase, this method can be useful in increasing reported costs, thereby lowering taxes.
In addition to the aforementioned-methods, another popular stock valuation method is weighted-average cost.
The Benefits of Stock Valuation
There are many benefits of performing stock valuation such as retail stocktaking and food & beverage stocktaking and following are some of them.
Determine Liquidity
The liquidity position of a business is something that interests most creditors and investors. By ensuring that current assets aren’t overstated or understated, proper stock valuation helps present the ‘true’ liquid position of a business.
Determine Income
Even a minor error in stock valuation can affect the numbers on your income statement, which results in results in an ‘incorrect’ net income. By performing proper stock valuation, you can correctly determine your business income.
Determine Financial Position
The largest current assets of any business are its stocks. So, even a minor error in stock valuation can result in incorrect financial statements, which in turn results in a ‘false’ financial position of the business. With proper stock valuation, these errors in the value of stock can be eliminated, which in turn can ensure correct financial statements and representation of the ‘true’ financial position of the business.
In addition to the benefits mentioned above, proper stock valuation can aid business decision making and help ensure the fulfillment of legal requirement. If you’re thinking of stock valuation or stocktaking and want to ensure that you do it properly, then get in touch with us today!
