A:

A company's working capital includes inventory, and increases in inventory make working capital increase. Working capital is calculated as the difference between a company's current assets and current liabilities. Inventory is classified as part of the current assets since there is an expectation that this asset is going to be consumed and produce economic benefits within a year.

Inventory

Inventory represents products a company owns and plans to use in its production process within the next year. Inventory can be in the form of raw materials, work in progress or finished goods. Raw materials can include commodities such as metal or oil, while work-in-progress inventory refers to goods that have undergone a certain level of processing on a company's production line but are not finished goods yet. Finished goods are products that are available for sale by a company. Certain companies such as clothing retailers do not have raw materials or work in progress included in their inventories due to the nature of their business.

Keeping inventory on hand is not only costly, as a company has to incur warehousing expenses, but it also presents an opportunity cost as the company could have done other profitable things with the funds invested in inventory. Also, inventory tends to become obsolete or even spoil, resulting in balance sheet declines and charges on a company's income statement.

Working Capital and Inventory

Inventory is an integral part of a typical company's current assets and working capital. For certain types of companies, such as general retail and grocery, inventory can represent a substantial part of the current assets with over a 70% share. For companies in the manufacturing industry, inventory may claim less than 10% of the current assets. Working capital can fluctuate significantly from year to year if a company underestimates or overestimates demand for its products. Also, many companies shift to just-in-time (JIT) inventory management, resulting in a smaller inventory share in a company's working capital.

RELATED FAQS
  1. How to calculate the inventory turnover ratio?

    The inventory turnover ratio is a key measure for evaluating how effective a company's management is at managing inventory ... Read Answer >>
  2. How do you calculate inventory turnover?

    Inventory turnover measures how many times inventory has sold during a period and provides insight into a company's inventory ... Read Answer >>
  3. How is work in progress (WIP) typically measured in accounting?

    Work in progress is usually measured and categorized as a current asset or a long-term asset on a company's balance sheet. Read Answer >>
  4. What is the difference between work in progress (WIP) and raw materials in accounting?

    Learn about the difference in inventory financial accounting between works in progress and raw materials, as reported in ... Read Answer >>
  5. What does a high inventory turnover tell investors about a company?

    Inventory turnover is an important metric for evaluating how efficiently a firm turns its inventory into sales. Read Answer >>
  6. How is the economic order quantity model used in inventory management?

    Understand what types of costs make up total inventory costs, and learn how the economic order quantity model is used to ... Read Answer >>
Related Articles
  1. Investing

    Measuring Company Efficiency To Maximize Profits

    Efficiency ratios can provide indications of profitability, shows how efficiently a company is being managed, utilizes its assets and handles liabilities.
  2. Investing

    U.S. Crude Oil Inventories Up (XOM)

    U.S. crude oil inventories are at “historically high levels” for this time of the year, according to the Energy and Information Administration.
  3. Investing

    Liquidity Measurement Ratios

    Learn about the current ratio, quick ratio, cash ratio and cash conversion cycle.
  4. Investing

    Can Oil’s Strong Recovery Last? (XLE, USO)

    New data shows weaker oil inventories, boosting energy companies and oil futures.
  5. Investing

    Best Time to Buy a House? NOW

    If you're looking to buy your first home, fall is the season when inventories are at their peak. The best time to buy a house could be right now.
  6. Investing

    Ratio Analysis

    Ratio analysis is the use of quantitative analysis of financial information in a company’s financial statements. The analysis is done by comparing line items in a company’s financial ...
  7. Investing

    Useful Balance Sheet Metrics

    These metrics can help you better understand the information found on balance sheets.
  8. Investing

    Reading the Balance Sheet

    Learn about the components of a company balance sheet - aka the statement of financial position - and how it relates to other financial statements.
  9. Personal Finance

    Why Create a Financial Inventory?

    Tom Zgainer of America's Best 401k shares why it's important for investors to take a financial inventory.
  10. Investing

    Crude Oil Headed Lower for the Week

    EIA reports rising U.S. crude inventories for the week and IEA sees lower oil demand in 2017
RELATED TERMS
  1. Inventory

    Inventory is the term for merchandise or raw materials on hand.
  2. Average Inventory

    Average inventory is a calculation that estimates the value or ...
  3. Average Age Of Inventory

    The average age of inventory is the average number of days it ...
  4. Inventory Reserve

    An inventory reserve is a contra asset account on a company's ...
  5. Business Inventories

    Business inventories is an economic figure that tracks the dollar ...
  6. Obsolete Inventory

    Obsolete inventory is a term that refers to inventory that is ...
Trading Center