Volume 13, Chapter 4
Inventory Valuation
Definition
Imagine reported profit has looked stronger than the actual cash in the bank for months, a gap nobody can quite explain. Eventually it traces back to fabric inventory being valued at old, outdated prices instead of what the remaining stock would actually cost to replace today. Fixing the valuation method doesn't change a single naira in the bank account. What it changes is whether the profit statement is telling the truth.
is putting an honest naira figure on everything currently held as raw materials, work-in-progress, and finished goods, the exact number Volume 07, Chapter 1 warned can't simply be assumed or estimated.
Recall Volume 07, Chapter 1's warning: inventory worth "₦10,000 on paper" may not be worth ₦10,000 in real cash today. Valuation is how that gap gets closed honestly, by choosing a consistent method and applying it every time, not by guessing.
Two Common Valuation Methods
| Method | How It Works | Best For |
|---|---|---|
| FIFO (First In, First Out) | Assumes the oldest stock is used/sold first; valued at its original purchase cost | Perishables, or materials whose price rarely changes |
| Weighted Average | Averages the cost of all units currently held, regardless of when purchased | Materials bought at varying prices over time |
Worked example, weighted average, MANIAC MINDZ fabric:
| Purchase | Quantity | Unit Cost | Total |
|---|---|---|---|
| Batch 1 | 10 rolls | ₦20,000 | ₦200,000 |
| Batch 2 | 15 rolls | ₦22,000 | ₦330,000 |
| Total | 25 rolls | ₦530,000 |
Weighted Average Cost = ₦530,000 ÷ 25 = ₦21,200 per roll
If 10 rolls remain in stock, they're valued at 10 × ₦21,200 = ₦212,000, not the original ₦20,000 or ₦22,000 batch price, but a fair blended figure.
Pick one method, apply it consistently, and never switch mid-year to flatter the numbers. The value of consistency matters more than which specific method is chosen.
Why Valuation Accuracy Changes the Real Profit Picture
Inventory sits on the balance sheet as an asset, over- or under-valuing it directly distorts Volume 07, Chapter 3's profit figures:
| If Inventory Is Overvalued... | If Inventory Is Undervalued... |
|---|---|
| Reported profit looks better than reality | Reported profit looks worse than reality |
| A future stock count "discovers" a loss that was always there | Selling old stock can create an artificially large profit spike |
Both distortions make Volume 03's business valuation less reliable too, the asset-based method depends directly on accurate inventory figures.
Example Story: The Valuation That Explained a Mystery
Here's the full version of the profit-mystery story from the start of this chapter.
MANIAC MINDZ's reported profit had looked stronger than the cash in the bank suggested for months, a gap traced, eventually, to fabric inventory being valued at outdated, lower historical prices instead of what remaining stock had actually cost to replace. Correcting the valuation method, and applying it consistently going forward, didn't change the cash in the bank at all, but it finally made the profit statement tell the truth, closing exactly the kind of confusing gap Volume 07, Chapter 4 warns about.
Across Industries
| Business | A Valuation Consideration |
|---|---|
| Golden Crust Bakery | Perishable ingredients need FIFO, old stock must be valued (and used) first |
| Green Fields Farm | Harvested crop valued at market price, which can shift significantly before sale |
| Nimbus Labs | Minimal physical inventory, but development time invested in unreleased features raises a similar valuation question |
Common Mistakes
Exactly the gap Volume 07, Chapter 1 warned about.
Makes periods impossible to compare fairly and misrepresents true performance.
Inflates reported assets, lower the value of, or fully remove, stock that's genuinely no longer sellable at its original value.
Quiz Yourself
Practice Exercise
Calculate the weighted average cost for your most-used raw material, using your actual last two or three purchase batches. Compare it to whatever value you're currently using in your records.
Quick Summary
Quick Summary
- Inventory valuation puts an honest number on raw materials, WIP, and finished goods, never guessed.
- Two common methods: FIFO and weighted average, pick one, apply it consistently.
- Over- or under-valuing inventory directly distorts reported profit and the business's own valuation.
- Volume 13 complete. Next, Volume 14: Quality Control covers what happens to the waste side of this volume's shrinkage-vs-waste split.