Look At All This Inventory: 3 Ways Retailers Account For What's On The Shelves

Zinger Key Points
  • Inventory turnover determines how a business is selling its inventory and how it compares to similar industry averages.
  • Lower turnover indicates poor sales and excess inventory.

The retail sector has had a rocky quarter. 

The scales were tipped when consumer giant Walmart Inc WMT reported lackluster earnings on May 17, followed by Target Corporation's TGT equally damning report on May 18 that showed both companies beat the Street estimates for revenues but missed on earnings per share.

What’s more, comparatively smaller retailers like Kohl’s Corporation KSS and Ambercrombie & Fitch ANF reported earnings in line with the companies mentioned above, missing expectations on either the top or bottom line.

Revenues and EPS aside, all of these retailers have more inventory than they usually do – another indication of the American economy's economic downturn.

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What does that mean for the companies?

Measuring Inventory Turnover

Inventory turnover determines how a business is selling its inventory and how it compares to similar industry averages. Lower turnover indicates poor sales and excess inventory, while a higher turnover suggests strong sales and less inventory.

Excess inventory stifles cash flow and is also a bear on the organization's assets, costing the company each day inventory sits on shelves.

Bloomberg reported on Wednesday that for investors to understand the consequence of stacked inventory, they must become familiar with something known as inventory accounting.

According to AccountingTools, there are four methods, but only three work for retail situations:

First in, First out (FIFO)

Like how restaurants use their inventory, the FIFO method assumes that items bought first are also used or sold first, which means that the items still in stock are the newest ones. This policy closely matches the actual inventory movement in most companies and so is preferable simply from a theoretical perspective.

Last in, First out (LIFO)
Under the LIFO method, you are assuming that items bought last are sold first, which also means that the items still in stock are the oldest ones. This policy does not follow the natural flow of inventory in most companies; the method is banned under International Financial Reporting Standards.

Weighted Average Method (WAM)

Under the weighted average method, there is only one inventory layer. Any new inventory purchases are rolled into the cost of any existing inventory to derive a new weighted average price, which is adjusted again as more stock is purchased.

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