What Is An Inventory?
An inventory refers to all the items and merchandise a company has available for sales to make revenue. In a more broad definition, inventory further refers to the list of stocks, products that are ready to be sold, and even the raw materials used for production.
In accounting, inventory could also refer to the company’s current assets and plans to sell as products. Depending on the industry, there are different inventory meanings, but they are all quite similar. In a manufacturing company, the inventory list includes the raw materials, the processed materials, and even the finished goods.
For example, in a pastry business, the flour, milk, sugar, and other ingredients will be listed as inventory. Furthermore, all baked goods, the ones set aside for quality check, and the ones ready for sale are all part of the inventory. In the hotel industry, on the other hand, vacant rooms could be enumerated in the inventory list.
An inventory can be as diverse as the industry it pertains to. However, there are certain types of inventories that we will look at in this guide, that can help you determine the scope of your assets.
Inventories help you better understand your business and utilize your resources. Holding inventory most times does not benefit businesses. It is more profitable for businesses when they sell out items. Merchandise ensures you manage your business well in a demand-driven situation. Let’s break that down; a well-kept inventory helps you know when you sell out the most and when you sell out the least. This can help you know when to meet up with demand and when to supply moderately, following a value stream map, for example.
34% of companies have shipped orders late because they mistakenly sold a product that was out of stock. This shows that not keeping proper inventory may lead to underperformance, decreasing customer satisfaction. By the end of this guide, you will understand exactly how to optimize your business and company with an inventory so you can adequately document your stock, track progress, and prevent wasting resources.
In this guide, you we will cover:
Is Inventory An Asset?
Inventory is generally considered an asset, as your inventory balance sheet contains the company’s current properties and capital, including all unsold effects. Once an item is sold from the inventory, it is a sold good and will now be on the company’s income statement. The merchandise a company has available for sale but is yet to sell is worth money; therefore, it is an asset.
Just from tracking your inventory you can learn many things and gain many insights into how well your business is doing. It’s important to note that inventory is always pointed out as an asset on your inventory balance sheet.
An inventory balance sheet recognizes your stocks as assets because money is spent on them and is of value. Items of weight you use for your business are assets, although they may not be for sale or resale. For example, when counting inventory in an office, the computers used for work will be counted as an inventory, therefore an asset. Although it is not stock to be sold or resold, it holds value and is instrumental in getting work done.
For clothing brands, having way too much stock on the ground is always a bad thing for the business, especially if it’s a fast fashion brand like Shein or Zara; the clothes go out of fashion within months, and no one wants them anymore. Proper inventorying can prevent situations like this and ensure you get sold out.
Still, in practicality, some unsold products may be an asset or liability depending on the nature of the items and how they are managed. Let’s elucidate this; for example, if you have stocks of fresh foods, they are included in your inventory, and are therefore also considered an asset. However, if these are not properly managed and stay with you too long, the seller, they could transform from asset into liability, as fresh food has a short shelf life.
The best way to strike a balance is to ensure you study your business through your inventory and take stock of raw materials and finished goods. This way, you can ensure you make only enough to prevent you from running out of stock, and you don’t produce too much that they become a liability.
When you have too much inventory on your hand as opposed to the amount you should be selling, this can also pose a problem. This is why you should always use an inventory checklist to keep track of what products are in stock, and which are in danger of becoming liabilities. Integrating great stock-keeping habits with checklists allows you to forecast demand for an expected and accurate outcome.
Types Of Inventory
An inventory can be defined as anything the company uses in the production of products and products. Inventories vary according to the company and the products and services they offer. It is vital to know the type of inventory you possess in order to understand how to manage and document it properly. Accurately tagging items, for example, can increase inventory accuracy from 63% to 95%.
In order for you to be able to better keep track of your inventory and create accurate lists and audits, we have broken down the four types of inventories:
1. RAW MATERIALS
A raw materials inventory lists all items that are needed to create your products. Raw here means that these items are in an unprocessed, unused state.
We distinguish between direct and indirect raw materials. Direct raw materials are actively involved in the process of making your products. For example, flour is a direct raw material for a pizza place. The baking oven, however, is counted as an indirect raw material that helps you in the process of production but is not used directly in the goods.
Work-in-process inventories, as the name implies, refer to all the goods that are being worked on. These include all raw materials that are in the process of being made into finished goods. This may sometimes even include labor costs, as that has to do with the production process. So direct and indirect raw materials are also work-in-process. For example, when counting inventory in a florist’s shop, the flowers currently being primed and arranged are a great example of work-in-process. They are not ready for sale and are also quasi-raw materials.
Another example would be a pizza in the oven; the pizza place can’t classify that as raw materials anymore as they are in the process of being made into finished products.
3. FINISHED GOODS
Finished goods are the products that a company has available for sale or distribution. This is the most recognized type of inventory. All the items you have available for the customers to make a pick from is considered part of the finished goods inventory. Examples of finished goods are pre-packed meals, clothes, toys, electronics, etc.
MRO stands for Maintenance, Repair, and Operating Supplies and refers to all the materials that are used for maintenance and repairs. This can include the gloves used in the packaging of items at the company or pens and staplers used in the office. Without these items, work can not go on. Although minute, they are crucial to accomplishing work on a daily basis.
Trying to keep track of all these inventories may seem daunting, but it is easy with thorough organization and the help of an efficient system or even software.
Inventory Management Techniques: 7 Tips
Effective inventory management starts with careful and detailled bookkeeping, as it includes ordering, stocking, and the use of the company’s materials. If a business wants to be profitable, then it is paramount you take your inventory seriously. Some businesses, for example, have too little stock, so they cannot meet customers’ expectations, while others have too much stock, which may sometimes not go well as it could make them lose when they cannot sell them all in time.
An efficient inventory is a balance between these two. Here are some tips for creating and maintaining an efficient inventory:
- Have a priority order for your inventory with the most important ones at the top. This will help you know which are expensive and which you need to focus on, being sure they sell out.
- Track all product information, like the SKU and the number of products available. This will help you know how much profit to expect and what each item costs for production. These factors will help you know how to stock and pride your items.
- Perform thorough audits of your inventory regularly to ensure that you are up to date with the information that you have. This could be weekly, monthly or yearly, or all of the above.
- To ensure that operations can run smoothly, you should assess your supplier’s performance to verify that they are in sync with your business needs. If you have a supplier that supplies later than you need, this could put a damper on your business. Discuss this with your supplier and be ready to switch if no change is effected.
- Understand your sales patterns, like when you make the least and most negligible sales, so you can manage your resources appropriately.
- Ensure that you have a laid down a system of recording any new inventory.
- Make use of a reliable inventory management system to keep everything under your control. This will make your processes more streamlined and easy to understand. It also displays the analytics you need to know about your business to make improvements.
How To Calculate Inventory?
Knowing your inventory is essential and you can calculate it with this simple formula:
Beginning inventory + Net purchases – COGS = Ending inventory
Ending inventory is the number of sellable goods you have at hand at the moment of the accounting period. For your inventory balance sheet to be offset, you need to know how to calculate your inventory, including all the available stock types.
Knowing the ending inventory of your business helps you estimate your tax; that’s why you must do this calculation correctly. Your ending inventory also corroborates that the number of remaining products on your inventory balance sheet is accurate and correlates with the number of goods in store.
Importance of an inventory in a business
The importance of an inventory in business can not be overemphasized as it is highly beneficial. Below are some of the benefits that you can expect from paying special attention to the tracking of your inventory:
- Gives you an insight into the bestselling product.
- Ensures you are capable of incoming orders.
- Helps you track and improve your profit.
- It helps you save money as you know exactly how much to stock, so you don’t overstock or understock. Reducing stock-outs and overstocks can lower your overall inventory costs by 10 percent.
- Increases cash flow as your money won’t be tied down in unnecessary supplies.
- Helps you meet up with customer’s expectations as you would attain accurate order fulfillment.
- Increased customer satisfaction as you can quickly and easily meet your customer’s demands.
- It limits employees’ probability of mishandling stock as everything is accounted for.
The average U.S. retail operation has an inventory accuracy of only 63 percent, which may give room for mismanagement of resources and inability to meet customer expectations. It’s essential to start your inventory management journey today for better clarity and greater profits in your business.