Final answer:
Knowing how a company values inventory is important when reviewing its financial statements as it directly impacts profitability and financial health. The method used to value inventory can affect metrics such as cost of goods sold, gross profit, and net income. Understanding this information helps stakeholders accurately assess the company's financial performance.
Step-by-step explanation:
When reviewing a company's financial statements, it is important to know how that company values inventory because it directly affects the company's profitability and financial health. The value of inventory on the financial statements impacts metrics such as the cost of goods sold, gross profit, and net income. The method used to value inventory can vary, such as the First-In-First-Out (FIFO) method, Last-In-First-Out (LIFO) method, or the weighted average method.
For example, if a company uses the FIFO method, which assumes that the oldest inventory is sold first, it may result in a higher reported net income and higher inventory value on the balance sheet during a period of rising prices. On the other hand, if the company uses the LIFO method, which assumes that the most recent inventory is sold first, it may result in lower reported net income and a lower inventory value during a period of rising prices.
Understanding how a company values inventory helps investors, creditors, and other stakeholders accurately assess its financial performance, profitability, and ability to meet its short-term obligations.