Importance Of Correct Valuation of Stock:Effect On Gross Margin,Net Income & Asset Valuation And Capital (Part 8)

It is important to understand the reason for the need to have correct valuation of stock.

Simply, any incorrect stock valuation will have direct impact on the gross margin of an enterprise leading right down to the bottom-line which is the net income/profit of an enterprise.

As the closing stock is in the current asset of the balance sheet, any overstatement or understatement will again overvalue the overall assets of the balance sheet. 

Based on the accounting equation concept ( Assets= Liabilities + Equity), this overvaluation of the stocks will lead to increase in owners’ equity.

Let’s look at the below illustration where the closing stock is overvalued from $1,000 to $3,000.

	OVER-STATE  Stock Valuation	CORRECT  Stock  Valuation	Difference/  Impact
Revenues	10,000	10,000
Cost of Goods Sold:
Purchases	5,000	5,000
Less :Closing Stock	3,000	1,000	Wrong/Over-valuation of Stock by $2,000
Cost of Goods Sold:	2,000	4,000
Gross Profit Margin	8,000	6,000	2,000(Increase)
Less: Overheads	5,000	5,000
Net Income/Profit	3,000	1,000	2,000(Increase)
Capital , End of Period			2,000(Increase)
Stock, End of Period	3,000	1,000	2,000(Increase)