Getting Started: Inventory Valuation

As you can probably imagine, each of these valuation methods has advantages and disadvantages. However, keep in mind that the only numbers that are changing are your cost of goods sold and ending inventory. The actual amount of cash you have in the bank from your sales isn't affected by the valuation method that you decide to use.

Analyzing a Company's Inventory

When it comes to inventory valuation, the magic word is "footnote." The footnotes to financial statements are home to all sorts of information about inventory valuation, including the valuation method used, changes in valuation method and the effects of LCM on a company's inventory.

Analyzing inventory is often less about the actual numbers than it is about understanding the thought processes used by management. Why did they choose this method for valuing inventory? Why was it necessary to devalue the inventory under LCM?

(For a course of action on what to do if you ever have the opportunity to meet with a company's management team, check out the special five-part series "Talking to Management," starting with "Part 1: The Big Questions.")

Because disclosure is paramount in the wake of the legal implications Sarbanes-Oxley has brought to corporate management, footnotes are required reading for anyone who wants to know about the skeletons in any company's closet.

While uncovering fraud like that at Bristol-Myers Squibb is best left to professional auditors , having a solid understanding of how a company values its inventory and how that valuation can affect the company's balance sheet and income statement can be valuable for any investor.

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