Having accurate inventory valuation is vital to the successful operation of your company. Your inventory valuation can impact the cost of your goods, your profit margins, your working capital, total assets, and more. Essentially, your inventory valuation is the amount of money associated with your goods at the end of a certain period.
One way to determine your inventory valuation is through the weighted average cost (WAC) method. This method is a good starting place for your business. It is great when you’re keeping track of incredibly similar items.
What is the Weighted Average Cost (WAC) Method?
In this method of inventory valuation, the cost of available goods is divided by the number of available units. This method is typically used when inventory items are practically identical, and make it impossible to give specific costs to individual units.
To calculate your weighted average cost, you need to divide your cost of goods available for sale by the number of units available for sale. When considering your cost of goods, take into account the sum of your net purchases and your beginning inventory. Once you determine your weighted average figure, you can use this number to assign a cost to the beginning inventory and the cost of goods sold.
By using this method, you’ll discover that the amount of on-hand inventory you have represents a value between the oldest and newest stock you’ve purchased. On the same note, the cost of goods sold will represent a value between the oldest and newest units sold during the period in question.
Pros of the Weighted Average Cost Method
The main advantage of the WAC method is its simplicity. It’s by far the easiest way to track your inventory and is perfect for new or small businesses. You don’t need to find out what batch your inventory belongs to in order to store it, and you don’t need to figure out the original cost of an item before you can price it.
You’ll spend less time with the WAC method thanks to its simple calculations, and there will be a lot less paperwork involved. Since everything is so simple, there’s less to keep track of and fewer records to maintain. Additionally, tracking your inventory costs money and man-hours, but with the simplicity here, you’ll spend fewer dollars overall.
Since the WAC method is used across all stock units, you’ll find that this method is incredibly consistent and is hard to manipulate. By choosing a different method such as LIFO (last-in, first-out) or FIFO (first-in, first-out), you’ll encounter a range of costs that can lead to variants.
Finally, the WAC method is good when your inventory is similar and incredibly large. If you’re trying to track a large number of items manually, the process can become time-consuming and tedious. However, the WAC method makes it easy and quick to keep track of everything.
Cons of the Weighted Average Cost Method
If your inventory prices vary quite a bit, this might not be the best method for your purposes. The idea is that, since the prices are weighted, you’ll sell less expensive items to make up for what you’re losing on the cost of more expensive items. But this doesn’t always happen, and you might not recover those losses and may even end up discontinuing an item.
Another disadvantage here is the limited room for variants. The WAC method assumes that all your units are exactly the same, but this often isn’t the case. You might get an item that’s had an upgrade or now comes with new features and therefore shouldn’t be priced the same as the older version of the same item. This situation is particularly impactful when the supplier gives this new version the same name as the old version.
WAC vs. FIFO vs. LIFO
As we’ve mentioned, the WAC method competes with two other methods for inventory valuation: FIFO (First In, First Out) and LIFO (Last In, First Out).
The FIFO method assumes that the first items you purchase are also the first to leave the warehouse. When you complete a sale, items are subtracted from the first list of products that came into your inventory.
On the other hand, LIFO assumes that the last items you purchase are the first to leave. Therefore, items are subtracted from the last list of products that have come into your inventory.
DEAR’s inventory management software provides you with a full range of costing methods and reports that help your business move the highest priority inventory, reduce wastage and gain greater transparency and control over your inventory.
Discover Your Ideal Costing Method with DEAR
Costing methods affect how the total value of your inventory in your accounting records is calculated over the course of time. DEAR uses actual accounting costing methods. The costing method applied to a product affects the order in which stocks are picked.
DEAR allows the following costing methods: FIFO, FIFO – Serial Number, FIFO – Batch, FEFO – Serial Number, FEFO – Batch, Special – Batch, Special – Serial Number. The specific method you should utilise depends on your industry and business, and we can help you determine what will work best.
For example, First Expired First Out (FEFO) is frequently used in the food industry, but other methods are more useful while First In First Out (FIFO) provides an effective method for many industries that need to move their oldest inventory first.
The Costing method assigned to each product will affect whether the system automatically picks stocks to fulfil an order or whether the stock can be selected by you. The costing methods that allow you more control in picking a stock are Special – Batch, Special – Serial Number.
Each method of inventory valuation has its advantages and disadvantages, so take some time to discover what works best for your business.
If you need some assistance, INNO is here for you. INNO is the official DEAR partner in China who helps small businesses to operate on the powerful cloud-based business software. DEAR cloud inventory management software provides coverage for sales, accounting, purchasing, inventory management, and so many more departments, giving you everything you need to run your business with confidence in one platform.
Try DEAR’s powerful and feature-rich inventory management software today and learn how accurate inventory valuation and costing can transform your business to a new level.
INNO cares about data accuracy since it is a core value for small businesses navigating the change of the market. Having developed a unique approach to on-going monitoring, we take clients through the beginning stage smoothly and they quickly learn how to operate the new software. At INNO, we believe it is essential to build up trust and empower staff and management to make well-informed decisions about the business with the help of powerful software.
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INNO founder Jano Tse has 12 years of experience in implementing ERP systems for foreign and local SMEs. He also specializes in the accounting process under China’s business environment. Jano’s passion for disciplined delivery and methods for meeting goals on time and under budget is exactly what INNO brings to each of the clients.
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This article was originally posted at Dear Systems.