What is Inventory?

Definition of Inventory

The accounting of things, component components, and raw materials that a corporation uses in manufacturing or sells is known as inventory. You perform inventory management as a business leader to ensure that you have enough merchandise on hand and to recognize when there is a shortfall.

The act of counting or listing objects is referred to as "inventory." Inventory is a phrase used in accounting to describe all goods in various stages of manufacturing. It is a current asset. Both shops and manufacturers can continue to sell or develop things if they keep stock. For most businesses, inventory is a valuable asset. While inventory is a balance sheet asset, having too much of it can become a practical liability.

 Examples of Inventory

Inventory models can be simplified by using real-world examples. The examples below show how different forms of inventory are used in retail and industry.

Raw Materials:

Fabric, leather, thread, and print designs are all components of a shoe manufacturing company.

Finished Goods:

Charm necklaces are made by a jewelry company. To make a finished object suitable for sale, staff connects a necklace to a preprinted card and slides it into cellophane envelopes. The final good's cost of goods (COGS) comprises the packaging it comes in as well as the work required to create it.

Work In Progress:

A cell phone is made up of three parts: the case, the printed circuit board, and the components. WIP is the process of putting the pieces together at a dedicated workstation.

MRO Products:

Copy paper, folders, printer toner, gloves, glass cleaner, and brooms for sweeping up the grounds are among the maintenance, repair, and running supplies for a condominium development.

Packing Materials:

The sealed bag containing, for example, flax seeds is the primary packing material at a seed company. The secondary packaging involves placing the flax seed bags in a box for transit and storage. The shrink wrap required to ship pallets of product cases is known as tertiary packing.

Safety Stock:

In case the roadway floods during the spring thaw, delaying delivery trucks, a veterinarian in a remote village stores up on disinfectant and dog and cat treats. To accommodate consumer demand, the veterinarian stocks up on these supplies.

Anticipated Inventory:

In preparation for the June wedding season, an event planner purchases inexpensive spools of ribbon and floral tablecloths.

Decoupled Inventory:

In a bakery, the decorators maintain a supply of sugar roses on hand to garnish wedding cakes, so they may keep working even if the ornament team's supply of frosting mix is late. Flowers are an integral aspect of the cake's design. They wouldn't be able to deliver a finished cake if the baker ran out of them.

Cycle Inventory:

As soon as a restaurant's final 100 paper napkins are used up, a new refill order arrives. The napkins are simply stored in the designated area.

Service Inventory:

A 12-hour-per-day cafe with 20 tables where diners spend an average of one hour eating a meal is open. As a result, its daily service inventory is 240 meals.

Theoretical Inventory Cost:

A restaurant intends to spend 30% of its budget on food but discovers that it really spends 34%. The 4% of food that was lost or squandered is referred to as the "theoretical inventory."

Book Inventory:

The theoretical stock inventory in the inventory record or system, which may differ from the real stock inventory when a count is performed.

Transit Inventory:

An art business places an order for 40 tins of a popular pencil set and pays for them. The tins are in transit as they are on their way from the supplier.

Excess Inventory:

A shampoo firm makes 25,000 special shampoo bottles for the summer Olympics, but only sells 20,000 once the games are over—no one wants to buy them, so they're obliged to discount or discard them.

Four Different Inventory Type?

Raw materials, WIP, finished goods, and MRO are the four primary forms of inventories. Some people, on the other hand, only recognize three types of inventory, excluding MRO.

Understanding the various types of inventory is necessary for making informed financial and production planning decisions.

Inventory  Types

Raw Materials:

The raw materials that a corporation employs to develop and finish items are known as raw materials. When the product is finished, the raw elements, such as the oil needed to make shampoo, are usually indistinguishable from their previous state.

Components:

Components are comparable to raw materials in that they are the materials that a company utilises to make and finish things, with the exception that they, like screws, remain recognizable after the product is finished.

Work In Progress (WIP):

Items in production, such as raw materials or components, labor, overhead, and even packing materials, are referred to as WIP inventory.

Packing and Packaging Materials:

Packing materials are divided into three categories. The primary packaging protects and makes the product usable. Secondary packaging refers to the final packaging of a product, which may include labels or SKU information. Bulk packaging for transportation is the tertiary type of packaging.

Safety Stock and Anticipation Stock:

The additional inventory that a corporation buys and stores to handle unexpected situations is known as safety stock. Safety stock has a cost of ownership, but it helps to maintain customer happiness. Similarly, anticipation stock is made up of raw materials or completed goods that a company buys in response to sales and production trends. A company may purchase safety stock if the price of a raw material is rising or if peak sales season is coming.

Finished Goods:

Items that are ready to sale are known as finished goods.

Decoupling Inventory:

Decoupling inventory refers to excess items or work-in-progress stored at each production line station to avoid work stoppages. Decoupling inventory is beneficial if separate elements of the line operate at different rates, and it is only applicable to businesses that produce items. Every company, on the other hand, may have a reserve of safety stock.

Cycle Inventory:

Companies order cycle inventory in lots to get the right amount of stock for the lowest storage cost. Learn more about cycle inventory formulas in the “Essential Guide to Inventory Planning.”

Service Inventory:

A management accounting concept, service inventory refers to how much service a business can provide in a given period. A hotel with 10 rooms, for example, has a service inventory of 70 one-night stays in a given week.

Transit Inventory:

Transit inventory, also known as pipeline inventory, is stock that moves between manufacturers, warehouses, and distribution hubs. It could take weeks for transit inventory to move between facilities.

Theoretical Inventory:

Theoretical inventory, also known as book inventory, is the smallest amount of stock a corporation need to perform an operation without having to wait. Theoretical inventory is mostly employed in the manufacturing and food industries. The real versus theoretical formula is used to calculate it.

Excess Inventory:

Excess inventory, often known as outdated inventory, refers to unsold or unused items or raw materials. Although a corporation does not intend to utilise or sell this stock, it must pay to keep it in storage.

Manufacturing Inventory

Inventory in manufacturing refers to objects that are in stock, as well as raw materials and components that are used to create commodities. Manufacturers keep a tight eye on inventory levels to ensure that there isn't a shortage that would cause production to halt.

Because each form of inventory has a different cost, accounting divides manufacturing stock into raw materials, work-in-process, and finished goods. Raw resources are usually less expensive per unit than completed goods.

In the service industry, what does inventory mean?

Every firm has a stock that helps it run its day-to-day operations. This inventory is intangible for service businesses. The inventory of a law firm, for example, contains its files. The firm's MRO is the paper used to print legal documents.

Inventory Control's Importance

Goods management enables businesses to purchase the proper amount of inventory at the right time. The technique, also known as stock control, aids in the optimization of inventory levels, the reduction of storage costs, and the prevention of stockouts.

The "Essential Guide to Inventory Control" has more information.

Best Practices of Inventory

Inventory best practices include careful inventory management. The business saying “If you can’t measure it, you can’t manage it” applies here. The first best practice is to track inventory. Others include:

Carry Safety Stock:

These products, often known as buffer stock, help organisations avoid running out of resources or high-demand items. When a company's calculated supply is depleted, safety stock is kept on hand as a backup in case demand rises unexpectedly.

Invest in an inventory management system that is cloud-based:

Companies can see where every product and SKU is in real time using cloud-based inventory management systems. This information allows a company to be more responsive, up-to-date, and adaptable.

Start a Cycle Count Program:

Time, money, and consumers are all saved. By keeping stock reconciled and customers pleased, the benefits of cycle counting extend well beyond the warehouse.

Use Batch Tracking:

Keep track of details for each batch or lot of a product. Some firms keep meticulous records, such as expiration dates, to keep track of their products' sell-by dates. Batch/lot tracking is used by companies who do not have perishable commodities to determine the landing costs and shelf life of their items.

Inventory Process

As work in progress, an inventory process tracks inventory as it is received, stored, managed, and withdrawn or consumed. The inventory process is essentially the lifespan of commodities and raw resources.

Read "The Essential Guide to Inventory Planning" for a diagram of the inventory process flow and more information.

Inventory Count

The act of counting objects in storage or a warehouse is known as an inventory count. The condition of the items is also checked during an inventory count. Inventory counts aid in the evaluation of assets and liabilities in accounting.

Counting your inventory can assist you figure out which items are selling well. Inventory managers can utilise this data to predict stock requirements and manage budgets. Read the articles "Taking Physical Inventory" and "Cycle Counting 101" to learn more about inventory counting.

Inventory Recording Methods

Periodic and perpetual inventory records are the two types of inventory records. You count stock at specific times and add the totals to the general ledger in periodic inventory. The perpetual technique involves keeping track of stock changes as they happen.

Although any sort of firm can employ periodic inventory, small businesses do so frequently, especially if there are no intentions to expand. The periodic approach does not necessitate the use of any specific software or equipment. Scanners and point-of-sale (POS) devices are frequently used to perform the real-time counting required for perpetual inventory. Read "The Periodic System: Is It the Right Choice?" and "The Definitive Guide to Perpetual Inventory" to discover more about each method.

Inventory Turnover

The number of times a corporation sells or uses an item in a certain period of time is known as inventory turnover. The figure might tell whether a corporation has an excessive amount of inventory on hand. Use the following equations to calculate inventory turnover:

Average Inventory= (Beginning Inventory + Ending Inventory) / 2

Inventory turnover = Sales + Average Inventory

Inventory Analysis

The study of how product demand changes over time is known as inventory analysis. This approach aids organisations in stocking the appropriate number of goods and forecasting future client demand.

ABC analysis is a well-known approach for undertaking inventory analysis. To do an ABC analysis, divide the items into three categories:

A inventory: The best-selling products that take up the least amount of space and expense to store are included in an inventory. According to several experts, this accounts for around 20% of your inventory.

B inventory: B items travel at the same velocity as A objects, but they are more expensive to store. In most cases, this accounts for around 40% of your inventory.

C inventory: The rest of your merchandise is the most expensive to store and yields the lowest profits. The remaining 40% of your inventory is represented by C inventory.

Advantages of Inventory Analysis

Inventory management improves earnings by cutting costs and increasing turnover. Other advantages of inventory analysis include:

Improves Cash Flow: 

Inventory analysis allows you to find and restock things that sell frequently, so you don't waste money on inventory that sits around for a long time.

Reduces Stockouts: 

You can better anticipate demand and avoid stockouts if you know which inventory items clients want the most.

Boost Customer Satisfaction: 

Inventory analysis provides information on what customers buy and how they buy it.

Reduces Wasted Inventory: 

Understanding what, when, and how much customers buy reduces the need to store obsolete products and allows you to plan ahead of time for when they expire.

Reduces Project Delays: 

Understanding supplier lead times will help you figure out whether to reorder and how to minimize late deliveries.

Improves Pricing From Suppliers and Vendors:

Inventory analysis can help you order large quantities of things on a regular basis rather than small quantities on a less predictable timetable. This consistency can give you a leg up on suppliers when it comes to negotiating reductions.

Expands Your Understanding of the Business: 

Inventory analysis gives information about your stock, customers, and business.

Advantages of Inventory Management and Accurate Inventory

A solid inventory management plan and accurate inventory counts can save businesses money by allowing them to spend solely on things that customers purchase and simplifying processes. More advantages can be found in the article "Top Inventory Management Advantages."

Accounting for Inventory

Inventory accounting is the process of counting and recording changes in stock value. Assets include raw materials, work-in-progress, and finished commodities. Inventory financial accounting gives a precise value of stock assets.

The value of stock items and the correct item count are determined by inventory accounting. These variables determine the cost of products sold and the final inventory value, both of which contribute to the overall worth of the company.

Average Inventory Cost

The average cost of inventory is a method of determining the cost of products sold per unit. Calculate the average cost by adding the costs of all available stock and dividing them by the number of things sold.

Weighted average cost is another name for this strategy. In the article "The Key to Using Inventory Cost Accounting Methods in Your Business," you can learn more about average inventory cost.