Understanding Inventory: Meaning, Types, and Business Examples

What is business Inventory?

Inventory is also known as the merchandise, in a business, which refers to the materials and goods which a business has for sale to its customers for the future. In simple words inventory meaning, the materials and goods act as items to be sold by a business for profit to the customers. These are neither used in producing anything nor for the promotion of business. Generating profit is the sole purpose of the inventory is for generating profit but if an asset is for sale it cannot be considered as inventory. For knowing whether an asset is inventory or not we need to check the characteristics of inventory.

For any service providing company the service offered by them at a specific time is its inventory. For example, a parlor, in a single day can offer its services to 20 customers which is its inventory.

What is the basic difference between inventory and asset?

The main difference between an inventory and an asset is that any company or a business that sells its stock for making money or generating profit is an inventory. On the other hand, an asset is for purchasing and managing inventory for aiding the company, so it has a different value.

Inventory is parts, materials and products and their quantity changes from time to time. It may change every day, month, quarter or year. Assets, on the other hand, are furniture, equipment, fixtures or any such things which remain constant over time. It may remain the same for years and might not be replaced often.

When considered in accounting, it is treated as a ‘current asset’ which a company or a business keeps for less than a year. Some other examples of current assets are expenses, accounts receivable and also insurance plans. Inventory that stays with the company after a period of one year is treated as obsolete inventory or deadstock and is often considered a liability.

Inventory – explainer

Assets are considered to be a part of the primary business of the company. For example, a person who owns a vegetable shop (a wholesaler) needs to deliver the vegetables and fruits in his truck. This truck is the asset here whereas the vegetables and fruits are the inventory. On the other hand, for a truck dealer, the truck is the inventory since they are selling it. So what is inventory depends on a case-to-case basis?

Secondly, all the product/services of the company’s assets should be available for selling things or should soon be available for sale. If any of the products/services of the company are never made available for sale then those things are not inventory. These are the investments or assets of that business.

Lastly, the main purpose of having products is to sell them to that company’s customers. Considering the vegetable business example discussed above, the truck was not for selling to any customer, rather it was bought to ship vegetables and could only be sold if the vegetable wholesaler decides to buy a new one or it has broken down.

On the flip side, the truck dealer has acquired the vehicles with the intention of selling them to customers. Therefore, for them, the truck serves as inventory. This principle holds true for various businesses. If there’s uncertainty about whether something qualifies as inventory or an asset, it’s prudent to assess whether it’s being sold to customers to generate profit or utilized to facilitate the selling process, such as delivery services or other related functions. This can be crucial when considering options like obtaining a business loan for a trucking company.

Inventory functions

Listed below are the most crucial functions of inventory:-

1. Managing demand and supply : It is one of the primary functions of inventory management, efficient inventory management helps manage demand and supply for the business

2. Knowing about the demand of customers and goods finished : Inventory management can help the entrepreneur in understanding customer preferences, and demand patterns. This can be done by carefully observing the inventory movement.

3. Component and raw material availability : Efficient inventory management helps the entrepreneur keep a track of the levels of raw materials and components used for producing goods. This can help the entrepreneur plan ahead and operate efficiently.

4. The major requirements for processing and its output

5. Knowledge of materials needed for production

Inventory count

This is a physical process of keeping a count of the inventory in a warehouse or storage. This court helps in checking the proper condition of the inventory and also maintaining it. This process also aids in assessing the debts and assets of a company. Inventory counts help in knowing whether a stock is selling out or not and how slower or faster. This information is further used in forecasting and managing budgets. 

Keeping inventory count

There are basically two ways by which one can keep an inventory count.

• Periodic count – Periodic count of inventory involves keeping a count of the inventory at regular fixed intervals, such as weekly, monthly, quarterly, yearly, etc. In this process, after every specific time period, the stock count is updated and then it is changed according to the ledger. Major benefit of this inventory count is the simplicity of process, cost effectiveness, and help identify errors and improve accuracy in numbers.
• Perpetual count – Perpetual count of inventory involves continuous updation of inventory for every marginal increase or decrease in the inventory levels. In this process, the inventory count is changed as the goods are shipped or sold to the customers. For this one needs to record counts as and when something is sold. Major benefits of this inventory count method is the accuracy in numbers as the same is updated on a real time basis and there is no lag in updation of data, which enables better decision making and enhanced efficiency.

Any business can use a period inventory but it is done by small organizations as keeping an update of the stock, whenever it is sold, in itself is a very tedious process if there is no proper equipment or software available. Companies who have POS or point-of-sale devices or automatic updation systems can update their inventory using real-time tracking for the perpetual inventory.

It also depends on the kind of business. For example, a company manufacturing toys does not necessarily need perpetual counting and they can easily keep stock using periodic counting. But a hotel needs to keep a perpetual count of their rooms that is available and the period count is not helpful for them.

Inventory turnover formula

It is the number of times any business sells a particular product or service in a fixed time span. This is used to know if any company has lots of inventory or too little inventory. For determining the turnover one can use the following methods:-

Inventory turnover = Average Inventory + sales

[Average inventory = (Ending Inventory+Beginning Inventory) / 2]

Average inventory cost

The average inventory cost is a simple calculation that finds out the per-unit cost of the products or services sold. For calculating the average cost, one needs to find the sum of stocks available for selling and divide it by the total items sold.

Advantages of Inventory Analysis

Inventory analysis is preferred by most businesses as it raises their profits by lowering their costs and increasing turnover. Some additional advantages  of inventory analysis are as follows:

• Improving Cash Flow: The practice of inventory analysis aids companies in identifying and reordering items that are more in demand so that their cash is not stuck up on inventory that is comparatively less in demand. Analyzing inventory movement can help understand product cycles in a great way which ultimately helps improve cash flow.
• Reducing the chances of stockouts: When one understands which product is much in demand, one can anticipate and keep a buffer stock of all those products thus ruling out chances of any stockout. Having a track of the inventory levels and an estimate around the time taken to use up the inventory can help the entrepreneur manage stocks efficiently and avoid stockouts.
• Increase in the number of satisfied customers: Inventory analysis offers insight into the demands of customers and thus makes it easy for businesses to satisfy their customers by keeping in stock all the products that customers need at a particular time. Doing correct analysis of inventory helps realize shortfalls in the products and how to overcome the same to offer a more comprehensive product to the customer in the future, thus increasing customer satisfaction.
• Reducing Wasted Inventory: Analysis of when what and how much people buy minimizes the necessity to store not-needed products thereby reducing wasted inventory. Inventory analysis helps the entrepreneur to ensure that on a forward moving basis, the entrepreneur is only filling up items that move quickly, and helps reduce wasted inventory.
• Reducing Delay in Projects: Analysis of the business habits of your supplier helps you understand when and what to reorder and how to prevent late shipments. By having this data available in advance, the entrepreneur can efficiently guess the timelines by when they’ll be running out of stock, and how early they shall reorder to avoid any stockouts in case of delayed shipments.
• Getting lower pricing from Suppliers and Vendors: Inventory analysis helps you in ordering high volumes of products that are in more demand regularly, vs. small volumes on a less reliable schedule. This huge size and regularity of your orders can put you in a better position to negotiate prices with suppliers and discounts if any.
• Expanding Your Insight of the Business: Analysing inventory provides you a deeper insight into your stock, your potential customers and your business overall.

What are the different types of inventory?

Below are few different types of inventory:-

1. Anticipation Inventory:

Plenty of businesses operate in anticipation of sales, this anticipation is backed by factors like seasonal surge in demand, new product launches, etc. to ensure there are sufficient products available. Such types of inventories are stocked by a company when one is anticipating some future demand for that product. They are accumulated before any peak selling season, some major vacation,  a promotion program, some festival season, or due to any kind of strike. For example, before any festive season, there is more production of sweets, nuts and chocolates by several food-based companies. Such inventory helps in boosting the production level and aids in reducing the change of production rates of the other productions.

2. Safety Stock or Fluctuation Inventory:

The inventory level is maintained for covering unpredictable fluctuations or random supply or demand or some lead time. Supposing any lead time or demand when the demand is greater than expected, a possible stock out of goods may occur. In such cases, safety stock is kept aside for protecting such a possibility. The main aim is to stop any kind of disruptions in the manufacturing of a company or delivering goods to the customers. It is also known as reserve stock or buffer stock.

3. Lot Size Inventory:

If the items are bought or manufactured in higher quantities than required in that current market scenario then it is called lot-size inventories. One can buy such inventory for taking advantage of some kind of discounts in quantities, for reducing the shipping time and also its cost, setup and clerical costs and also in cases when it is not possible for making or buying any items at the same rate which is sold or used. Such an inventory level is also known as the cycle stock. Such a portion of the inventory gets finished as more orders is dispatched to the customers.

4. Repair, Operating and Maintenance Supplies:

There are plenty of businesses which have a high post sales serviceability scope. Once the product is sold, its maintenance requires raw materials, which is an ongoing process even after product sales are discontinued. Operating, repair and maintenance supplies are such items that are generally used for supporting the maintenance and general operations of the company but may not be a direct part of any product. It includes spare parts, consumables and maintenance supplies, like lubricants, cleaning compounds, erasers and pencils. 

5. Raw Materials Inventory

This is used to create final finished products which are processed by the company. This inventory is only applicable to companies that manufacture products. They cannot be recognized after the product is completed.

6. Components inventory

Components are quite similar to the raw materials but they can be recognized in the finished products. This inventory is also only applicable to companies that manufacture products. These products can be primary products, or even secondary products complementing an existing primary offering in the market.

7. Work In Progress (WIP) Inventory:

This inventory refers to those items which are under production and als0 includes components, raw materials, overhead, labor, and other packing items. Applicable to companies that produce products.

8. Finished Goods Inventory:

This inventory consists of the products which are ready to be sold to the customers. This inventory is applicable to both manufacturers and resellers. Businesses who are into trading i.e. buying and selling of finished products by identifying and filling demand and supply gaps usually hold inventory of finished goods, also businesses with quick inventory turnover can also choose to store finished goods inventory.

9. Packing and Packaging Materials Inventory:

This inventory is for packing the goods. There are generally three types of packing done.

• First, one to protect the product from environmental conditions and prevent them from damaging or decaying
• The second is for packing these goods and including information related to the product. It is generally beautifully decorated.
• The third is to pack the order in bulk for transportation. Generally, done in big cartons.

10. Decoupling Inventory:

This inventory method is used for storing extra items or the WIP inventory which is kept at the production line station for preventing work stoppages. This method is quite useful if different machines work at different speeds for processing the goods. Only useful for manufacturing companies.

11. Service Inventory:

This is related to companies that offer services rather than products. For any service inventory or management accounting concept, it refers to the service any business can offer in the said period. For example, any spa with 5 rooms can offer its services to 300 customers in a period of 10 days. Expansion of inventory in such cases is usually capital intensive, and it is imperative for the entrepreneur to work on an efficient inventory model to ensure profitability.

12. Transit Inventory:

This inventory takes care of the stock which is constantly moving to the distribution centers, warehouses and manufacturers. It takes around several weeks to move from one facility to another. It is also called pipeline inventory. Online shopping companies are the best examples of transit inventory.

13. Theoretical Inventory:

This inventory method is for maintaining that stock that can be completed in any company in the least possible time which doesn’t include longer waiting periods. It is generally used in the food processing industry. It is also known as book inventory.

14. Excess Inventory:

Any inventory which has gone unsold or consists of raw materials that are not used but any company needs to pay for storing it is called excess inventory. This also contains any stock which may not be in demand then but can be used up later.

Examples of inventory and it’s different types

1. Anticipation Inventory:

For winters, the companies manufacturing their cosmetic products related to winters increase their production in anticipation of the winter season. Whenever there are any countrywide strike the petrol consumption increases so the businesses increase the petrol inventory.

Another great example would be seasonal holiday decoration material. Anticipation inventories are maintained based on the sales outlook and expected demand to cater to the customers efficiently while ensuring no deadstock.

2. Safety Stock or Fluctuation Inventory:

Gold is quite a fluctuating inventory so before Diwali or wedding season, the jewelers store gold and process it as a safety stock.

3. Lot Size Inventory:

Before the rainy season, a business buys a lot of umbrellas, raincoats and boots. This is a lot size inventory. The inventory levels are maintained in bigger lot sizes citing the fact that such products usually have a high and consistent demand where the suppliers usually fulfill orders in larger quantities due to the nature of product and businesses.

4. Repair, Operating and Maintenance Supplies:

It can include the cleaning supplies like mops, brushes and other products which are related to the maintenance of machines and are usually kept in supply by machines.

5. Raw Materials Inventory

The oils used in shampoos are the raw material for the company manufacturing shampoos.

6. Components inventory

Clothes used for manufacturing garments are components inventory. Another example would be auto parts used for the two-wheeler and four-wheeler industry. These industries have a high demand potential considering the fact that the components are used widely and fairly consistently.

7. Work In Progress (WIP) Inventory: 

The different parts of a bicycle which are used for completing its structure at a workstation can be considered as WIP inventory. 

8. Finished Goods Inventory:

Chocolates that are finished and processed are called finished goods inventory.

9. Packing and Packaging Materials Inventory:

Chips, biscuits and wafers are packed in big cardboard boxes and wrapped in plastic rolls. So, here plastic rolls and big cardboard boxes are packaging materials inventory. Not only these but almost everything available in the market requires packing, hence the scope of this industry is huge and so is the need for inventory.

10. Decoupling Inventory:

An event management company keeps in stock the artificial flowers so that in case the real flowers are not delivered, then also they can decorate the venue using the artificial flowers. Here, artificial flowers are decoupling inventory.

11. Service Inventory:

A hotel that has 200 rooms on any given day can entertain 200 people in a day. Here, 200 rooms are the service inventory. Although the scope of overutilization is none, managing and understanding the capacity and ways to optimize the same is fairly easy for service industry based inventory management.

12. Transit Inventory: 

Online shopping companies or couriers or shipping companies are the best examples of transit inventory.

13. Theoretical Inventory:

Any hotel which expects to spend 20% on the cleaning of rooms but finds that it has spent 24%. Here the excess 4% is theoretical inventory.

14. Excess Inventory:

Any company selling sweaters, after the winter season, is forced to store its stock till next winter. So this stock of sweaters is excess inventory. Excess inventory can result from seasonal dip in demand, or due to other externalities due to which the inventory at hand may become a little difficult to move for the time being. This however, can be resolved by leveraging some unique approach to increase sales.

Inventory Process

The inventory process is a method used by companies or businesses for storing, receiving, managing, withdrawing and using inventories while producing final products or reselling them. Basically, it is a cycle for monitoring the raw materials and goods bought.

Inventory Analysis process This process helps in finding business how the demand for a particular service or business changes from time to time. This analysis aids the business to keep the stock of the products and project what the customers want in future.

The inventory analysis is done with the help of ABC analysis. ABC stands for:-

Inventory Accounting

Inventory Accounting is a system that records the various changes in stock value. Finished goods, WIP and raw materials are different assets. Any financial accounting inventory offers a correct value of such assets which helps the companies in the resources required.

Benefits of Inventory Management

Proper inventory management will help the companies in finding out the money that needs to be spent on the products which customers purchase and ease the operations.

Demand Forecasting

This is a practice of finding out the demands of the customer by checking previous purchase trends, like seasonality and promotions. Correctly predicting demand aids in a better knowledge of the inventory one needs and reduces this need for storing extra stock. Entrepreneurs can be enabled to forecast the demand trends more accurately by leveraging past sales and inventory data. The data around finer points such as the seasons during which the inventory turnover is high, what is the average number of days of inventory, which products are stored for how many number of days, which products sell more in which season, etc. all these data points can give some great insights to help forecast demand.

Why is inventory control important?

Knowing the inventory helps a person know about its supplies and stock. So the company can easily find what they need and when they need it. So that one can buy the required inventory at the right time. This process will help in processing inventory levels, prevent stock-outs and reduce storage costs. It is also known as stock control. For an entrepreneur, both the events of stockout and stuck inventory for a loong time in the form of deadstock is counterproductive for the business. A good inventory control helps avoid such situations by effectively managing inventory levels. The decision of maintaining these deal inventory levels backed by past data and solid and realistic expectations, can really help avoid such precarious situations.

Best Practices in Inventory

When we talk about inventory best practices, what we actually mean is careful management of inventory. The saying “If you can’t measure it, you can’t manage it” totally applies here. Hence the first and foremost best practice is to keep track of inventory. Other practices include:

• Using Lot or Batch Tracking:
  Some businesses record all information associated with every lot or batch of a product. Recording such precise details as expiry dates, etc. provides them information about their products’ sellable dates in case their goods are perishable. On the other hand, those companies whose goods are not perishable use batch/lot tracking to assess their products’ shelf life or landing costs.
• Investing in a Cloud-based Management Program of Inventory:
  Such management systems make companies have the knowledge in real-time as to where every product and SKU are spread across the globe. This data aids in making an organization more up-to-date, more responsive and more flexible.
• Keeping Safety Stock:
  Safety stock, also called buffer stock, helps companies in emergency times from running out raw materials required for preparing high-demand or popular items. Sometimes owing to some unforeseen circumstances when companies drain off their calculated supply of raw materials, safety stock comes in handy as a backup in case of the level of demand increasing unexpectedly.
• Starting a Cycle Count Program:
  Besides saving money, time and customers, benefits of cycle counting extend well beyond the warehouse by keeping whole stock reconciled and thereby all the customers happy.

Inventory FAQs:

11. How Do You Define Inventory?

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