People often ask about inventory valuation using an alphabet soup of terminologies such as FIFO, LIFO or Averages. These methods are fine from an accounting standpoint and maybe over a long period of time, but they are really not accurate for whats really going on in the day to day business.
Is there a better way? Yes, High 5 Software has developed a better way of valuing inventory by using true inventory value in SME. We did it this way because we had to in order to track serialized inventory and then achieved the benefit of better financial tracking. See below for details and an example.
Inventory Valuation in SME
SME inventory management is BETTER than both FIFO and averages. In fact one of our customers just switched all inventory accounting from QB to SME because neither FIFO or averaging gives a complete picture. For this customer, QuickBooks inventory valuation was wrong somewhere between between $0 to $4.2M, but they did not know until they tracked values in SME only.
Instead, SME uses ACTUAL costs. It tracks every lot being received and this is necessary for serial number tracking of parts. Now within a single lot, SME will use FIFO, but if one lot is different from another lot, it would use actual.
For example, you are selling Widgets and Equipment (serialized):
- You order 10 widgets and 5 equipment today for $10 and $100 respectively. (Lot 1)
- The next day you order 10 widgets and 5 equipment for $20 and $200 respectively. (Lot 2)
- Total Widget inventory value is $300 (10*$10 + 10*$20).
- You sell 1 widget and 1 equipment. SME allows you to specify the specific lot used or serialized equipment. Therefore you get real, true costing.
- Let’s say you select the widget and equipment from lot 2. SME would deplete the $20 and $200 items. SME would tell you that the cost of items remaining are 10*$10 + 9*$20 for widgets or $280. A FIFO system would take the $10 part even though that’s not the one used and tell you inventory value is 9*$10 + 10*$20 or $290, but this is wrong!. An average system would say the average cost is $15 and say inventory is worth $285, which is also wrong.
So in summary, SME gives true inventory valuation instead of false accounting information. Over the long term FIFO and average may work out from an accounting standpoint, but wouldn’t you want to do better with SME?! Note that you can always run a report in SME to give inventory average numbers if you really want accounting right, but reality wrong numbers!