How to find the true cost of your stock

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The importance of strategy for entrepreneurs in Kenya is to be able to replicate their work. This helps. Are you even Kenyan if you don’t have multiple hustles? On paper, solid strategies enable your different sources of income run with as little intervention from you as is possible. This is with regards to your overall goal.

Much of the strategic choices we have emphasized have been outward-looking. We have touched on the processes and consequences of fast versus slow growth. We had a look at whether small business owners should prioritize marketing or product. There was also a brief look at the payoffs of emphasizing one of revenue and profit. These are just a few examples.

These outwardly metrics are easy to define and fun. You can use our elected leaders as a reference. Oh, they love erecting billboards and putting up posters against their development projects. You can do that for bins but not for people, exclusively, dumping trash in them.

That’s where the introspective choices of your business come in. These are the kinds of stuff that, “if you do them well, people will think you do nothing at all.” One such choice is in calculating the true value of your stock.

There are different methods of valuating your stock. You should limit yourself to only those allowed by the International Financial Reporting Standards (IFRS). Kenya is compliant to the same. So, this affects how your financial records are perceived by financial institutions.

Value of your stock

Why should you do this besides presenting records to some bank? They’ll probably find another reason to say no. The overall reason is that stock valuation helps you work around ever-rising costs of supplies – because inflation.

This will enable you draw more reflective financial statements. As with depreciation, at times you may miss the true levels of profit or loss that your business is realizing. Your cost of goods is a component in calculating profit. Therefore, it’s only good to use true figures.

Another thing, stock is one of your, if not the, biggest investment in business. Stock is a current asset. It would benefit you to accurately estimate their value at the end of your business year or cycle.

For what it’s worth, the readings of your stock valuation help you plan for working capital. It will not end all your challenges but who says no to help? This is just one aspect of resource allocation in your business that will get better because of finding the true value of your stock.

Which method suits you?

If you’re in Kenya, there are really only two methods to value your stock (unless something changed). You can match cost to sales of individual products but that’s not realistic for most small businesses. It’s too much work anyway.

The two alternatives are the Weighted Average and the First-In-First-Out (FIFO) methods. Your choice, as with everything, depends on your situation and goals. What’s the math behind the two:

Week Quantity Price Total Cost
One 10 sh.100 sh.1000
Three 8 sh.125 sh.1000
18 sh.2000

 

Weighted Average

You only need to find the average price you spend to buy from your supplier:

2000 ÷ 18 = sh. 111.10

If you sell 13  products for sh.130 each, your gross profit would be:

Sales(130 * 13) – Cost (111.10 * 13)

Stock you remain with (18 – 13) in your balance sheet would be:

111.10 * 5

The weighted average enables you to smooth out your cost of buying stock. Despite the variation in prices, you can see that we find a single price for the financial statements. But you know how deceptive average can be. It makes the expensive items cheaper.

FIFO

It gets a little complicated with this. You sell 13 of the products (130 * 13). The cost is based on the order in which they were supplied to you. The first ones you bought are the first to go is the thinking.

You would determine cost of the “first” 13 products you bought, at their respective prices. So:

(100 * 10) + (125 * 3)

For your balance sheet, the price of the most recent products you bought is what you’ll use. So, 5 products remain unsold:

(125 * 5)

FIFO follows a good flow of your inventory. You want the items you bought first to sell fast. This encouraged high turnover. It also gives a true value of your stock, as assets. But it doesn’t match cost of goods to current prices. Your business may read more profitable than the actual situation.

If you find it hard to keep up with varying prices by your suppliers, weighted average could simplify your life. If you sell perishables or fast moving goods, FIFO is usually advised. The catch is that you should use them for the same products – which is why prices are compared in the first place.

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Web Content and stuff. You can reach me you know: editor@herbusiness.co.ke, malitrobert@gmail.com

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