Accounting is crucial to a manufacturing business as it provides the financial information that determines a company’s profitability. Accounts are prepared to determine the price of products sold. They also help a business determine its liquidity by assessing the value of finished products. To understand why accounting is essential to a manufacturing business, learn more about the different types of balance sheets and the purpose of accounting in manufacturing.
Accounting help businesses make better decisions about pricing and inventory levels.
The best companies know their inventory levels, and that’s a good thing, but it’s also essential to keep track of all types of inventory. Accurate tracking of inventory levels allows businesses to provide proactive customer service to clients. A simple and effective way to track inventory levels is to use ABC analysis. ABC analysis divides products into three categories based on their consumption value and impact on annual inventory costs. Categories A and B comprise the most valuable products, while Category C comprises the least valuable products or those with minimal consumption value.
With the proper use of accounting tools, manufacturing businesses can better understand their inventory management. Inventory management involves managing physical assets, from the components purchased to the finished product. Inventory management is an active part of production, and it needs the same attention and care as other capital assets, such as production equipment. As a result, accounting for manufacturing businesses and inventory are valuable capital assets, and they can even exceed the value of production equipment.
Accounting help determines the liquidity of a business.
A manufacturing business’s liquidity is often determined by its current ratio. For example, a low current ratio may indicate the company is not liquid enough to meet its liabilities. On the other hand, a high current ratio indicates that it has sufficient cash on hand to meet its obligations. This ratio is commonly called the acid test ratio because it excludes stock, which can take time to turn into cash and be knocked down.
Cash and inventory are two of the most important aspects of a manufacturing business’s liquidity. Both types of money and inventory must be accounted for accurately. Without sufficient liquidity, the company could face insolvency, requiring a costly restructuring process, a fire sale of its most valuable assets, or bankruptcy. Regardless of the reason, this lack of liquidity can be a problem for any company, mainly if an unexpected bill or cash shortage arises.
Accounting help determines the value of finished products.
In manufacturing businesses, accounting helps determine the value of finished products by calculating the cost of produced goods. Finished goods are defined as assets that are not readily sold and are recorded on the company’s balance sheet as inventory. Inventory valuation is calculated by taking into account the cost of purchased materials and summing the price of each product in the market. As such, stock refers to the number of finished goods that a company has at the point of sale. This figure helps determine the final cost of the stock.
For a manufacturing business, finished goods inventory is vital for its finances. While this type of inventory is necessary to run a successful business, it requires more detailed accounting than non-inventory businesses. To reduce the amount of inventory a company maintains, it can decrease its inventory by encouraging suppliers to own a portion of it on-site, implementing supplier drop-shipping programs, and other methods of reducing inventories.