What is inventory?
A basic definition could be:
“The quantity or value of the current stock of a manufacturer or retailer. This can include raw materials and parts that will be used later in the manufacturing process. The managing of inventory is vital for the smooth running of a business, and the science of inventory management is required to ensure that your supply network will work without hiccups.”
Inventory is all the components used in production or sales in your business. It’s up to you as a business leader to ensure that you always practice the right inventory management strategies to keep the right amount of stock on-hand.
The verb “inventory” can also refer to the act of listing or counting items that are available within the business environment. By keeping stock of what’s going on with a current asset count, companies can ensure that they’re ready to serve clients with the right number of finished products.
What is Inventory Management?
Inventory management will involve not just controlling the amount of stock that you have but the time necessary for replenishment of stock, asset management, carrying costs of the inventory, forecasting, visibility, physical space for inventory, the return of faulty goods, valuation, and future price forecasting. When you take care to ensure that all these details are taken care of, your inventory will always be balanced and you will never run out of stock. Inventory turnover is considered one of the most important aspects of a business as it is responsible for generating cash, and thus profits.
Your definition of inventory might also include exposure to terms like “Inventory Process” or “Inventory Counting”. An inventory process is a solution that tracks the inventory as companies receive, use, and manage it as a work in progress. The inventory process tracks the lifecycle of the goods and raw materials that move through your business.
Alternatively, an inventory count refers to the act of counting items that you hold in storage for your inventory. The count may also look at the condition of the items and keep that information stored so you can check it at a later date. Inventory counts assess your stock situation, but they also help you to determine which stocks are moving well.
Examples of Inventory
A business's inventory is nothing more than the raw materials, parts and finished goods kept on site or in its warehouses. Inventory can also be held on consignment, which is when a third-party holds inventory for a business until the goods have been sold. Inventory is reported as an asset on a business balance sheet, and is a buffer between the manufacturing and order fulfillment stages. Once the inventory has been sold, or used in the manufacturing process, the cost of carrying it flows into the cost of goods sold in the accounting statement.
There are three different types of inventory that can be tracked; raw materials, work in progress, and finished goods.
- Raw materials are the raw starting materials that fuel the manufacturing process. Raw materials are such things as the metals used by steel or auto companies, or the food and spices used by food processors.
- Work in progress is anything that has been partially processed, but is not yet a finished good. This would include an automobile that hasn’t been completely assembled, or raw dough in a bread or cake making factory, among other things.
- Finished goods have gone through all manufacturing steps and are ready to be sold to wholesalers, distributors or consumers. Examples include finished automobiles, computers or televisions, and the loaf of bread you buy at your local grocery store.
A crafts company selling pots might send a pot to a customer in a finished box, with a card that explains what it took to make the item. The cost of goods for the finished product includes the costs of everything from applying the barcode, to shipping the product out to customers.
Businesses realize that holding a large amount of inventory for a long period of time is not good business practice. It can lead to spoilage or obsolescence and can be quite costly. Of course it isn’t good to hold too little inventory either, since the business could miss out on some potential market share and sales. Striking a balance is the key, and this has led to the role of inventory management within manufacturing organizations, with the Just-In-Time (JIT) inventory system being one preferred way of managing inventory levels.
Other Types of Inventory
Other types of items that might be included in an average inventory will depend on the kind of business that you run. Options might include:
- MRO goods: Maintenance, repair, and operating requirements
- Packing materials: The packing material that you use to send the product to the customer. This includes the initial packaging that the product comes in, or would be displayed on a shelf with, as well as additional packaging for shipping.
- Safety stock: This is the additional stock that you keep on-hand in case of an increase in demand. For instance, a vet might have extra antibiotics in their practice, just in case.
- Anticipated or smoothing inventory: To cut costs, you might buy extra inventory outside of peak times. For instance, an event planner could buy tablecloths after the wedding season in June ends.
- Decoupled inventory: Decoupling inventory is the extra inventory you might need to finish working if something goes wrong. For instance, a bakery might keep extra stores of sugar designs on-hand in case the team runs out of frosting.
- Theoretical inventory costs: If you aim to spend 40% of your budget on manufacturing supplies, and you discover you spent 42%, that 2% would be the theoretical inventory that was lost or damaged.
- Cycle inventory: Following the FIFO inventory practice for first-in, first-out, when you go through all your supply of one stock, the cycled inventory would fill the supply back up again. For instance, once you run out of paper, your regular supply of paper would go back into the paper slot in your inventory.
- Service inventory: A service inventory is based on the amount of business you’re likely to do. If you have a café that’s open 10 hours a day with 12 tables, each of which seats a customer for one hour, the average service inventory would be 120 meals for each day.
- Transit inventory: If you purchase 20 dresses for your clothing store, the dresses on route to you from your supplier would be in transit.
- Excess inventory: If you produce a selection of 500 special prints for an art store, and you only sell 300, the 200 simply aren’t getting any extra attention, they would be excess.
Specialist Inventory for a Specific Vertical
Understanding your needs as an eCommerce company and keeping all the correct cogs turning in real-time with your inventory management solution takes a lot of effort. It’s important to understand now just how inventory works, but how it works for your specific company.
For instance, in manufacturing, your inventory for small business processes might include things like in-stock items, raw materials, and the components used to make your goods. Manufacturers keep a close eye on inventory levels and work in process to ensure that there isn’t a work shortage.
Accountants will generally divide manufacturing stock into work in progress, raw materials, and finished goods, because all the different kinds of inventory come with different costs to consider.
In the service industry, accounting methods might be different. In the service landscape, your inventory to suit customer demand is intangible. For instance, a law firm’s inventory would include any files it creates for customers, and papers that the documents are printed on.
Inventory Best Practices
Running a successful company means understanding your inventory, ensuring that you have a strong supply chain, and a strategy for managing your stock. Good inventory management means having a strategy, from LIFO to FIFO, knowing how to avoid stockouts, and more. As you continue to work with distributors and discover how your inventory works, you’ll begin to develop better practices to maintain efficiency. Some good strategies include:
- Using safety stock: Having buffer stock in place will help you to deal with fluctuations in demand when you get more orders than you expect.
- Invest in inventory account tools: Using cloud-based tools for inventory management will help you to keep track of where every product and SKU might be. This helps you to have complete inventory control.
- Start cycle counting: This process saves you time and money by ensuring that you can keep track of the sales cycles and keep customers happy.
- Use batch and lot tracking: Make sure you always record information associated with every lot and batch of a product. Some companies might use precise details, with expiration dates, whereas other companies just use batch and lot tracking to keep track of shelf lives.
Managing your Inventory
Good inventory accounting and recording is a crucial part of running a successful business. You can record inventory either periodically, or perpetually, using your inventory management system. If you use periodic accounting in your inventory management software, you’ll count stock at certain times. The perpetual solution is a little simpler because you track stock changes as they occur.
You can also keep a close eye on your inventory turnover with the right technology. This will give you an insight into things like lead time, and whether you should use first in, or last-in last-out strategies to ship inventory items.
Conducting inventory analysis on your stock levels is also important, as it will show you how demand changes for your products over time, A common form of inventory analysis uses the ABC method. This means that you reorder your goods into three categories:
- The A level: The A inventory includes any best-selling products that don’t demand a lot of space for storage. This accounts for about 20% of your inventory in total.
- The B level: These items move at a similar rate to A items, but they cost more to store overall. This represents around 40% of your inventory.
- The C level: At the C level, you count your remaining stock, which may be more expensive to store, and return a lower profit margin.
The ABC analysis leverages the 80/20 principle and reveals that 20% of your inventory should deliver up to 80% of your profits. Companies may need to focus on these items when they’re trying to generate more profits quickly.
The Benefits of Good Inventory Analysis
A good inventory analysis allows you to keep track of how much stock you actually have, so you know you’re already ready to tackle customer demand. However, there are also a range of other benefits to explore too, such as:
- Improved cash flow: Inventory analysis shows you which items you sell the most, so you can spend money on the things that move fast.
- Reduced stockouts: When you know which inventory is most important to your customers, you can anticipate demand more effectively.
- Increased customer satisfaction: Analysing inventory offers better insight into how consumers purchase items.
- Reduced waste: Knowing what your customers need and how they buy reduces the need to store excess products. This ensures you have a better strategy for using resources.
- Reduced delays: Understanding supplier lead times will help you determine when to reorder for your inventory to reduce late shipments.
- Improved pricing from vendors and suppliers: If you order more high volumes of products on a regular basis, you can negotiate for discounts.
- Expands your business understanding: You’ll get an insight into your customers and how your business operates.
Ending Inventory Issues: Terms to Know
An effective inventory management strategy can involve a variety of different tools and practices. The more you know about your inventory, the easier it is to make decisions that will benefit your business and deliver positive outcomes long-term.
Here are some valuable terms to keep in mind when you’re exploring your inventory options.
- Demand forecasting: Demand forecasting refers to the process of trying to predict customer demand by looking at your perpetual inventory trends. You can examine things like promotional impact and seasonality and see whether they have an impact of sales. Predicting demand can help you to ensure that you have enough stock, without over buying.
- Inventory management: An inventory management strategy allows you to maintain an accurate view of your inventory to save money for companies. When you know what your customers are buying from you, you know what you should be stocking up on.
- Average cost: The average cost of inventory is a practice used for calculating per-unit cost of goods you buy. You start by getting the sum of the cost for all the stock you have for sale, then divide it by the total number of sold items. The method can also be called weighted average cost in some cases.
- Inventory records: Inventory records are what help you to track the stock you’ve bought and sold over a certain period of time. You need to measure the number of items of inventory you’ve purchased and sold to ensure that you have the right balance
- Annual physical inventory: This is a manual process of counting the physical items you have on hand at any point during the year.
- 3PL/ 4PL: A third party logistics provider, 3PL, works in logistics and supply chain management when a business outsources a portion of its distribution and fulfilment services. 4PL integrators accumulate resources and technologies to cover the more comprehensive supply chain.
- Enterprise resource planning: This is the process a company uses to manage and integrate various important parts of the business to keep things running as they should. The right ERP system can integrate things like purchasing, planning, sales, inventory, finance, and marketing.
- Initial mark-up: The difference between the initial price you paid for the inventory, and the amount you charge your customers. It’s important to ensure that you make a profit with the item, as well as covering a portion of the overhead expenses associated with collecting and managing your inventory over time.
Good inventory management and control assists companies in buying the right amount of inventory at the correct time to generate positive outcomes. The process of good inventory management reduces storage costs, stockouts, and purchasing issues. It’s a crucial part of running a successful business.