two companies, the same inventory figure
A food company holds inventory worth KD 2 million that turns over every 25 days and earns an 18% profit margin. Another company holds the same inventory at the same value, but it consists of materials bought nine months ago that have not moved, while the company bears storage and insurance costs.
On the balance sheet the figure is the same: "Inventory". Behind it, though, is a completely different story. The first company uses its inventory to generate sales and cash; the second has frozen part of its money in items that do not move.
This is where the question that should concern financial management begins: do we measure inventory by what appears on the balance sheet, or by its ability to turn into cash without a loss?
Higher inventory does not always mean abundance
A rise in inventory may have explanations that need following up:
- Buying in bulk for a discount without studying turnover: a company bought 10,000 units at a 10% discount but sells 200 units a month, so it needs 50 months to clear the quantity.
- In co-operative societies: 3,000 food baskets bought for a Ramadan project, 1,800 distributed and 1,200 still left after six months, some of which need an expiry check.
- In contracting: steel and building materials bought at a high price before the market fell, and still carried at the old cost.
This is where IAS 2 comes in. It requires inventory to be measured at the lower of cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business, less the costs of completion and the costs to sell.
If this value falls below cost, or the inventory is damaged or obsolete, its carrying amount must be written down. Slow movement alone is not conclusive evidence of impairment, but it is an indicator that calls for review. It is important to distinguish between slow-moving inventory (which may still sell at its original value) and inventory that is obsolete or impaired.
Lower inventory can be efficiency
An industrial company working on weekly supply holds inventory covering only 15 days, so it does not pay rent for large warehouses or bear high spoilage risk. An educational institution orders books and supplies each term instead of storing a year's worth. A co-operative society has contracted a supplier to deliver against weekly demand instead of storing six months in advance.
This lower level can be healthy and reflect good cash-cycle management, provided it does not cause stock-outs or disrupt operations.
Inventory costs you more than its purchase price
A company may buy inventory at a good price that can be sold, but it takes six months to turn into cash. During that period the company bears costs that do not appear directly in the inventory value: warehouse rent and insurance, financing costs tied to the frozen cash, spoilage and obsolescence, and the opportunity cost.
Illustrative example: For inventory of KD 1 million held for 180 days, with an annual financing cost of 8%, the approximate financing cost is about KD 39,500. That figure does not include rent, insurance or spoilage.
Inventory can be sound in accounting terms yet weak in economic terms if its expected return is lower than the cost of holding it. At that point, the focus must move from tracking its value to measuring the efficiency of the money invested in it.
IFRS 18: clearer presentation of performance
The new standard, IFRS 18, does not change how inventory is measured under IAS 2, but it strengthens the clarity of financial performance presentation and the requirements for classifying expenses in the statement of profit or loss. When cost of sales rises, it becomes more important to understand: did purchase costs rise? Production costs? Inventory write-down losses? And is there slow-moving inventory affecting efficiency?
IFRS 18 does not deal with slow-moving inventory as such, but it makes its effect on performance easier to read. It is mandatory for annual periods beginning on or after 1 January 2027, with early application permitted.
Three reports to request this week
Report one: inventory turnover
Turnover = cost of sales ÷ average inventory. Average holding period = 365 ÷ turnover. A turnover of 12 times a year ≈ 30 days, 6 times ≈ 61 days, and twice ≈ 183 days. These are general indicators that vary with the nature of the business and seasonality.
Report two: inventory ageing
Request a report showing the value of items that have not moved in 90, 180 and 365 days, with the reasons for the slow movement and the proposed action. The periods are a management model that can be adjusted to suit the business.
Report three: net realisable value
Compare cost with net realisable value, identify damaged or obsolete items, estimate the costs of completion and sale, and document any write-down. Relying on the market price alone is not enough.
In co-operative societies: inventory is a responsibility before it is a number
A co-operative society holds food inventory worth KD 500,000 in preparation for a particular season, and part of it was left undistributed. Management should ask: can it be distributed? Is it still fit for use? Does it need a write-down? Can it be returned to the supplier? And was the purchase decision proportionate to actual demand? In co-operative societies, inventory may also represent a responsibility towards beneficiaries.
Questions for the board of directors
Do not only ask: what is the value of inventory? Ask:
- What percentage of inventory has not moved in 90, 180 and 365 days?
- What does it cost to hold slow-moving inventory?
- Are there items that are past their expiry or no longer saleable?
- Has inventory been valued at net realisable value?
- Is the quantity in line with expected sales?
- Can part of it be cleared, returned or used in another activity?
- How much cash could be released if we reduced unnecessary inventory?
Conclusion
The balance sheet says: you have inventory worth KD 2 million. On its own, it does not say how much of it moves, how much is waiting to be sold, how much it costs you to hold, and how much may need to be written down.
Inventory is not just a figure in current assets. It is cash that has left the company and is waiting to come back. The longer it waits, the more important it becomes to ask about its movement, its value and the cost of holding it.
Inventory that does not move does not necessarily mean a loss, but it may be the start of a loss that management has not yet noticed. The problem is not the size of the inventory, but management's ability to turn it into cash before it changes from an asset into a burden.
