- Posted on
- Riley Draper
Newly owning a business often comes along with accounting terms we aren’t familiar with. And if we aren’t clued into the financial side of things, it can all get confusing.
That is often when we make mistakes and the business bleeds profits. That’s why in this article, we want to go over the difference between inventories and fixed assets. We will also discuss how to implement and manage fixed asset inventories.
What is Inventory?
Inventory can mean a variety of things, depending on the type of business. In accounting terms, physical inventory is a current asset on the balance sheet referring to all stock in various production stages. These assets are component parts and raw materials that a business will either sell or use to produce its product. Inventory is expected to be turned into cash within a year.
The word inventory is also used as a verb. Businesses “inventory” the inflow and outflow of their stock and engage in inventory management practices to make sure there is enough on hand and to immediately identify when there is a shortage.
TYPES OF INVENTORY
To break it down, let’s examine five major inventory lists that businesses may keep track of. They are:
- Raw materials and components: Raw materials are the materials a company uses to create products as well as finish them. These materials are often unrecognizable from their original state, such as olive oil used to cook a dish served at a restaurant. Components are similar to raw materials because they are also materials a company uses to create goods as well as finish them. However, they are still recognizable as their original state when the product is completed. For example, a screw is a component part of a chair that remains recognizable even when the manufacturing process is completed.
- Work In Progress (WIP): This type of inventory will include all items currently in production, such as raw materials, components, labor, overhead, and packing materials used to work on the product.
- Finished goods: Those goods that have been completed and are ready to sell are called finished goods.
- Maintenance, Repair, and Operations (MRO) Goods: This type of inventory focuses on the supplies that go into making a product or helps maintain the business itself.
- Packing material: A packing material inventory will include the items the business uses to pack its product for sale. An example would be the tube toothpaste comes in. It could also include the boxes or packaging used to ship or store the product.
It is important that businesses don’t have too little or too much inventory. Too little can cause demand to go up, which will raise profits and possibly lose customers. Too much can mean spoilage of goods, which equals liability and waste. Oftentimes the annual inventory audit will find a discrepancy between the recorded amount of stock on the books and the actual counted goods. This deficit will be logged as an operating loss.
What are Fixed Assets?
There are several types of fixed assets. Let’s go over them one by one.
TANGIBLE FIXED ASSETS
Tangible fixed assets, or capital assets, refer to physical property that can be touched that are purchased for long-term use in business operations. Long-term use would be considered anything used by the business to generate income for at least one fiscal year.
Tangible fixed assets are commonly represented as property, plant, and equipment (PP&E) on the balance sheet. These assets may also be consumed or converted into cash. Common fixed assets used by businesses include:
- Office furniture and equipment (printers, chairs, etc.)
- Computer hardware and other technologies
- Vehicles (company cars, tow trucks, semi-trucks, forklifts, etc.)
INTANGIBLE FIXED ASSETS
Those assets of a business that are not made of physical material, yet not monetary, are called intangible fixed assets. Businesses can either create or acquire intangible assets. Those that are created by the company will not appear on the balance sheet since they have no recorded book value. These can include things like:
- Brand name
- Brand recognition
- Domain names
- Confidential information
- Intellectual property
Intangible assets can be either definite or indefinite. An indefinite intangible asset is an asset that has no foreseeable limit to the cash flow it generates. There are no legal or contractual limiting factors. Examples would include goodwill, trademarks, or brand name.
Definite intangible assets include any intangible asset with a limited life. This could include anything under a legal agreement attached to it, such as operating under another company’s patent for a set amount of time.
FINANCIAL FIXED ASSETS
Any monetary assets of the company are called financial fixed assets. These include assets such as:
- Mutual funds
- Bank deposits
- Loans granted to borrowers
Expenses related to fixed assets (except the financial ones) should be depreciated or amortized in the books, rather than be fully deducted from the business’s income. For tangible assets, this is done by depreciating their cost according to their expected useful life.
The useful life of an asset refers to an estimate of the number of years an asset is considered useful to a business before its value is fully depreciated. It must be greater than one year. Once the asset comes to the end of its useful life, it can be salvaged or disposed of.
For intangible assets, amortization is calculated by taking the difference between the asset’s cost and its expected salvage or book value, then dividing that figure by the total number of years it will be used.
The Difference Between Inventory vs. Fixed Assets
Now that we’ve gone over both the concepts of inventory and fixed assets, we can compare their differences. So what’s the difference? Let’s explore.
PERIOD OF TIME
Fixed assets are created or purchased for long-term use. This could mean anything that will be a part of the business for a year or more. On the other hand, inventory is meant for short-term use only. These items are meant to stick around for less than a year when they are to be converted to cash.
Keeping inventory items for long periods can be risky due to spoilage, theft, damage, etc. When you buy a computer for your business, you are expecting to keep it for over a year because it is a fixed asset, while supplies like pens or paper cups will not last nearly as long.
Therefore it would not be profitable to keep inventory for the same amount of time fixed assets serve a business.
Directly correlated with the period of time an item is kept is depreciation. Since inventory does not usually stick around for over a year, there is no depreciation to keep track of. However, fixed assets need to be depreciated and amortized annually. It is important that businesses depreciate their tangible assets and amortize their intangibles. These costs must be calculated on a yearly basis.
The purposes of fixed assets and inventory vary. Typically fixed assets are those assets used to run the business, while inventories are the goods and products to be sold and those supplies and materials that help make them.
The longer you keep something, the more risk you take on. Fixed assets tend to have more risk involved since they are kept by the business for longer periods of time. They are also typically larger purchases which can be a greater loss if the asset is lost, damaged, stolen, mismanaged, dysfunctional, etc.
Inventory, on the other hand, poses smaller risk since these items are kept for under a year. Businesses commonly attempt to sell out all the stock in order to make fresh new inventory. This helps reduce spoilage and other possible losses that can occur.
Due to the potential varying risk factors of fixed assets, it is a good idea to maintain a fixed asset management system by using a fixed asset inventory.
What is a Fixed Asset Inventory?
Both your business’s inventory and fixed assets need a tracking system to ensure financial statements are accurate for tax season or when you need to get a loan. A fixed asset inventory is a tally of the fixed assets a business has that allows the CFO to track and maintain assets through time.
Create a system that allows you to:
- Calculate depreciation and IRS property taxes on your fixed assets for accounting
- Monitor maintenance needed for your fixed assets
- Schedule repairs for fixed assets
- Monitor stock levels (avoid overstocking or stockouts)
- Assess the asset’s current location, original cost, market value, use, state of repair, and usefulness
- Document and update as changes occur
- Check serial numbers, tag number, or barcodes to quickly assess asset’s status
- Input purchase orders for low inventory goods
Determining which fixed assets to track can be directly determined through setting a capitalization threshold.
BENEFITS OF KEEPING FIXED ASSET INVENTORIES
Implementing a fixed asset inventory is a good foundation for your asset management system. Here are the most important benefits you will find:
- Accurate financials: Fixed asset inventories focus on providing accurate financial data for fixed asset accounting purposes and other financial reporting. Verifying the asset records annually will help keep the inventory as accurate as possible.
- Better control: They also help create an exhaustive and detailed look at what assets and inventory are on hand, allowing better control of the assets. Having better control allows you to be more prepared for a negative financial event or unexpected setback. This allows your business to fully thrive.
- Minimize loss: An organized, efficient system will help minimize things like theft and deterioration of goods. When you’ve implemented preventative maintenance plans for your high-dollar assets, you are helping maintain the asset value for longer periods. This means they’ll be around longer, eliminating the need to buy more.
- Make more informed decisions: help you make better, more informed decisions for your business. Having a birds-eye view of your business assets allows you to improve planning and accurately budget.
- Save time: Keeping close track of your valuable business assets will save you time trying to locate certain assets, purchase replacements, and look up the asset information. When all the information is right there, you will breeze through inventory.
- Save money: The efficiency gained by regularly maintaining a fixed asset inventory will best of all, allow the company to save money on overpayment of added expenses. This of course equals more profit, which is ultimately one of the business’s core goals.
ASSET TRACKING SYSTEMS
Asset-intensive businesses would benefit most from implementing an asset tracking system, allowing them to easily carry out asset management inventory processes.
Some options to help track assets are:
- Barcode asset tracking: You may notice that some physical assets you purchase have a barcode label. There are apps that include scanning software that can help you scan and log these items, right from your phone or other mobile devices. This allows you to share information with other team members who use the app.
- Radio-frequency identification (RFID): RFID asset tagging allows the location of your assets to be broadcasted. An RFID system consists of a radio transponder located in the tag, a radio receiver, and a transmitter. This is especially helpful for those businesses that can’t have any mistakes in their tracked assets.
- GPS tracking system: It is also possible to use a tracking system that we are probably all familiar with: GPS. GPS locations are transmitted through satellites of cell networks, allowing you to use mobile asset-tracking devices to communicate across distances. Set up a geofence that alerts you when an asset is moved out of a specific location. That way you’ll know if something is taken somewhere it wasn’t supposed to be. This is a good idea for businesses that need an accurate, real-time log for all the team members using them, such as trucking companies that rely on fleet management systems.
These three systems should be used along with asset-tracking software. There are tons of software out there to choose from, notably Sage Fixed Assets and AssetWorks. Choose the one that works best for your organization’s goals.
Getting Clear on Definitions
In this article, we’ve discussed inventory in two different ways. When used as a noun, the inventory refers to the component parts, raw materials, and supplies in various production stages to either sell or use to produce a product. Fixed assets, on the other hand, are the tangible, intangible, and financial assets used to help run a business long-term.
The term fixed asset inventory is to be used more as a verb; it is the act of inventorying the fixed assets in your business through an asset management system.If You Like Please Share It: