Three accounting statements define the financial health of a business: the income statement, the cash flow statement and the balance sheet. The income statement identifies what was sold; the cash flow statement explains how cash came in and went out; and the balance sheet summarizes the resources used in running the business. Unlike the income or cash flow statements, the balance sheet is composed of two-parts, assets and liabilities, and when added together always equal zero—hence the name “balance” sheet. By accounting convention, inventory is listed on the assets side of the balance sheet. In this writers’ opinion, nothing could be further from reality. As in practice, inventory looks more like a liability than it does an asset.This is true for five reasons:

• Inventory is purchased on credit, which uses up a company’s liquidity
• Inventory consumes administrative, physical, and transactional resources
• Inventory is inherently perishable and decreases in value the longer it sits
• Inventory can only be disposed of profitably by transforming it into products
• Inventory reduces a company’s ability to respond to the marketplace

Yes, you read the last item correctly—I said reduces a company’s ability to respond to the marketplace. And it does so no matter which way the market moves. How can this be? First, consider that when an up-tick in demand occurs, even if you have every line-item on hand to build the product (which you won’t) you’ll still be limited by the availability of short-term manufacturing capacity. Unless you’ve mastered lean manufacturing—which means you wouldn’t have the inventory in the first place. Second, when a down-tick occurs, well… that’s obvious. Just think back a few years to how valuable your inventory was then.Third, when the market goes quiescent, like all complex systems do from time to time, it begins to evolve. Current products get updated, new products get released, and old products get eliminated. In business, a flat sales-line is just as catastrophic as a flat-line in the operating room—it requires an immediate “call to action.” None of which bodes well for the inventory sitting on the self. Lastly, markets sometime spontaneously revise their supply solutions. A case in point is Wal-Mart, which decided they didn’t need OEMs to fulfill their low-end notebook requirements and started buying from Taiwanese ODMs direct. Ouch.So whether markets go up, down, sideway, or off into some new supply territory, inventory slows a company’s reaction-time and makes it less nimble. Inventory’s ranking on the balance sheet, second only to cash and receivables, is also misleading. In accounting terms, the higher an asset is listed the more liquid it’s considered to be so inventory’s position seems hopelessly outdated.Current assets, from an operational perspective, are structured to offset current liabilities, like in your checking account. Money comes in from earnings; money goes out to pay bills. If there is a surplus, you transfer it down the asset side of the balance sheet into long-term investment. On the other hand, should an unforeseen shortfall beset your checking account; debt in the form of over-draft protection can be added to current liabilities to make up the difference. But inventory takes a long time to convert to cash, and just like that overdraft loan it continues to create a liability as long as it’s outstanding. So how can inventory be considered a current asset? Maybe the concept has crept forward with us out of antiquity. A classification rooted in the days when folks went out “a counting” how many sheep they had grazing in the fields, which unquestionably they thought of as assets. We’ll never know.What we do know, however, is that regardless of where it’s listed on today’s balance sheets, inventory is not — and will never be — an asset.