Some businesses may reap the benefits/ profits of holding inventory due to steep price increases (only if they are able to transfer these price hikes to their customers). Often businesses may choose to hedge themselves against fluctuating inventory prices/ commodity prices which directly drive their inventory prices. More on this will be covered in our Hedging blogs. However for now, since we are focusing on inventories, let's take a look at the impacts of fluctuating inventory prices on income statements, if the firm chooses not to hedge it.
Inventories often see quite fluctuations in their prices owing to commodities price fluctuations at times. One such case study for readers’ learning is Supreme Industries. Management of the business have explained that the business saw a crazy increase in Inventory gains due to a crazy rally in PVC prices. This gain was clubbed as part of Inventory which boosted the earnings for the year.
Source: MD&A AR 2021 Supreme Industries
We can also verify this crazy increase in prices from PVC futures data from Investing.com.
Source: Investing.com PVC futures data
Similarly, there can be cases of Inventory losses too, where inventory goes to waste and the company has to bear those costs.
Case Study: Control Print
Control print is in the business of coding and marking, the application of printing ink or etching the material substrate to produce something that is visible and legible so it can be read by humans or machines.
The major risk of the business is technology. As the technology & consumer preference changes, they also need to quickly change their product mix to adapt to the new Technology making their old products outdated and less preferred in the industry.
Source: AR-2018 MD&A
As a result, the business has to write down their inventory which is of old technology (whose demand wouldn’t be the same upon arrival of new Tech in the industry). Upon taking a look at this company’s AR, you will see that they write down their inventory regularly. Inventory worth 612.85 lakh was written off in 2018 through exceptional items.
Source: AR-2018
However, Control Print shows Inventory write off in exceptional items (which ideally are like one offs) where the business should have included it in the normal/ ordinary expenses/ COGS. The classification of this item as exceptional can be questioned by an analyst.
Now the reader might think, why are we even bothering on the classification, as long as it is present on the income statement, irrespective of the header, it will be reducing the net income, right? True, however, as a standard practice, many analysts on the street tend to back out these extraordinary items from the net income and compute adjusted net income to judge figures in a consistent manner (computing net income as if that extraordinary item never happened!). Though the idea is right, backing figures out without understanding the natures of those figures might hurt the intent with which we were adjusting net income in the first place! Like in this case, if an analyst were to adjust net income for the extraordinary loss of inventory write off, it would be wrong since it's not an extraordinary item!
However, the intent of this article is to enlighten the reader, how inventory gains and losses, eventually impact the financials of the business and we hope the reader has gained a new perspective on the same.