What Is Inventory?
Inventory is the stock of goods a company holds with the intention of selling to customers. It typically comes in three forms: raw materials waiting to be used in production, work-in-progress items partway through manufacturing, and finished goods ready for sale. Because inventory is expected to convert into cash within a year, it is classified as a current asset on the balance sheet.
Not every company carries meaningful inventory. A software business may hold almost none, while a retailer like a grocery chain or an automaker may have billions of dollars tied up in it at any given time.
How It Works
When a company buys or produces goods, the cost is capitalized on the balance sheet as inventory rather than expensed immediately. Only when the goods are sold does the cost move to the income statement as cost of goods sold (COGS), matching the expense to the revenue it generated.
Companies use costing methods such as FIFO (first-in, first-out), LIFO (last-in, first-out), or weighted average to decide which costs flow into COGS. Analysts also watch inventory turnover, calculated as COGS / Average Inventory, to judge how quickly a company sells through its stock.
Example
Suppose a sneaker retailer starts the year with $2 million of inventory, purchases $10 million of shoes during the year, and ends with $3 million on hand. Its cost of goods sold is $2 million + $10 million - $3 million = $9 million. If the retailer generated $15 million of revenue, it earned $6 million of gross profit on those sales.
Why It Matters
Inventory ties up cash, so managing it well directly affects working capital and free cash flow. Rising inventory that outpaces sales growth can signal weakening demand or looming markdowns, which is why analysts track it closely each quarter.
In investment banking interviews, inventory often appears in accounting questions: an increase in inventory is a use of cash on the cash flow statement, and a write-down of obsolete inventory hits the income statement and flows through all three financial statements.
