Understanding Inventory Obsolescence and Why It Matters

Inventory is often one of a company’s largest assets and largest uses of cash, but certain items can lose their value or become unsellable over time. This situation is known as inventory obsolescence and can occur when products go out of style, new technology replaces old models, demand declines, or goods sit too long on the shelf.

Obsolete inventory needs to be written down, or reserved against, to reflect its lower value and ensure that the financial statements accurately show what the inventory is truly worth. Inventory must be valued at the lower of cost or net realizable value, meaning whichever is less between what you paid and what it’s expected to sell for after related costs. This keeps your financials accurate and prevents overstating asset values.

Regularly evaluating your inventory for obsolescence is both a required accounting practice and good business management. Identifying slow-moving or outdated items helps companies make better purchasing and production decisions, control costs, and improve cash flow. Proactively managing obsolete inventory allows businesses to recover cash from items that no longer add value and apply those funds toward more profitable products or working capital needs. From a financial reporting standpoint, accurate valuation also ensures compliance with accounting principles generally accepted in the United States of America.

When it comes to an audit, having a supportable and well-documented approach to inventory obsolescence is important. Auditors will typically review sales history, aging schedules, and subsequent sales or disposal activity to verify that management’s estimates are reasonable. Without this documentation, inventory valuations may be challenged or adjusted during the audit process, which could affect reported profits and delay financial reporting.

By staying proactive and regularly reviewing inventory, maintaining clear documentation, and applying consistent valuation methods, businesses can reduce audit stress, strengthen financial accuracy, and gain valuable insight into their operations and cash flow.

Managing inventory obsolescence goes beyond meeting accounting standards. It affects your cash flow, profitability, and the confidence of lenders and investors. Contact 415 Group to discuss how we can help you evaluate your inventory, develop a practical reserve policy, and ensure your approach supports both compliance and business strategy.