Definition

All the raw material that a business uses to produce goods and the ready for sale products that a business possesses is referred to as Inventory. It is a form of asset for a business.

All inventory is categorised and recorded as current asset on the balance sheet. The inventory mainly comprises of three types of goods:

1. Raw materials: The assets that a business uses in the production process to produce the final product.

2. Work-in progress: The unfinished product held by a business not ready to be sold yet.

3. Finished goods: Ready to sell products possessed by a business not sold yet. These products are usually held by a business in warehouses.

The value of inventory is important to be evaluated by a business as it is an asset stored by the business which incurs costs of storage. The value of the inventory can be evaluated in various ways though, depending on the accounting method followed by the business.

The three ways in which inventory can be valued are as follows

1. FIFO: First in first out method which calculates the cost of goods sold on the basis of the cost of earliest purchased materials.

2. LIFO: Last in first out method states that the cost of the goods sold are calculated based on the value of the raw materials purchased last.

3. Weighted average method: States that the value of inventory is calculated based on the average cost of the total raw material purchased by the business.

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This post deals with inventory part of the books of accounts, which is an important indicator for investors to study the financial health of a company.

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Accounts Receivable

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on the concept of accounts receivable.

This read will help you get started with understanding accounts receivable and its significance.

Introduction

Accounts Receivable appears in the balance sheet of a company when an entity (an individual or a company) purchases goods or services on credit from the company and the payment will be received later.

It is the amount of money owed by the customer for any purchase that is made on credit. Quite often, business sells products/services to its customers but the payment is made in the future and issues an invoice for this same in the meantime. This invoice signifies that the product has been sent but the payment is to be done within a specified future date. These are a form of short-term debt since they are to be paid back in a short span. The time for the payment is usually from about 30 days to a few months.

Example

Company A that sells broadband service usually provides the service for the month, but the payment is typically received at the end of the month. This means that even though the service has been provided, the payment is pending hence making it an accounts receivable.

Mostly, businesses provide credit purchases to customers with whom they have frequent transactions. This enables them to avoid the hassle of payments every time a transaction occurs. It also helps build a good relationship with its clients by providing them an ease of payment.

Accounting Treatment

As discussed, since Accounts Receivables is like a short-term credit line to clients hence it is treated as a short-term asset in the balance sheet. It falls under ‘Current Assets’ since the payment is received in the short term. For double entry, the credit side of the same is recorded in the income account as a sale. Once, the payment is made the cash in the balance sheet will increase and the accounts receivable will decrease. For goods like raw materials, there is a variation in inventory in the revenues and a decrease in the Asset side under ‘Inventory’.

The increase or decrease in accounts receivable from the prior period is also recorded in the Cash Flow Statement.

Final Words

Accounts receivable are crucial to every economy and it differs based on various factors and is taken in control by policy makers whenever needed. As a student curious about Finance, learning about accounts receivable will go a long way in the future to understand better how liquidity and prices in the economy is maintained.

Relevance to the SimTrade certificate

This post deals with Accounts Receivable and its significance on the book of accounts of a company.

About theory

By taking the SimTrade course , you will learn more about the markets. It’s important to remember that accounts receivables are an important to assess it to understand the financial health of a company you would like to invest in.

Take SimTrade courses

About practice

By launching the series of Market maker simulations, you can extend your learning about financial markets and trading approaches.

Take SimTrade courses

About the author

Article written in October 2021 by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Inventory

Inventory

Definition

The three ways in which inventory can be valued are as follows

Final Words

Relevance to the SimTrade certificate

About theory

About practice

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