Inventory is a term used by businesses and accountants to record items that are:
- Raw materials used to make items for sale
- Work in progress goods
- Finished goods for sale
A business’s inventory is categorized as one of its main assets. For example, if you own a restaurant, your kitchen equipment, tables, chairs, tills, and food stock, all form part of your inventory.
Examples of Different Types of Inventory
Examples of raw materials that constitute inventory could be metal used in construction projects or car manufacturing or hops used by breweries to make beer or grapes used by wineries to make wine, and so on.
Examples of work in progress inventory could be items in the process of being made for sale. For example, if you have a factory that makes cars, a half-finished vehicle would be a work in progress inventory item. Or, if you’re a clothing manufacturer, all your clothing that’s not quite ready for the store would also be a work in progress inventory item.
Last but not least, examples of finished goods for sale are items that have passed both the raw materials and work in progress stages and are ready to be sold. Some business owners call such goods “merchandise.” Some examples of this type of inventory are clothes, cars, food, or electrical goods such as TVs, phones, and computers. Pretty much anything you buy as a finished product either online or in-store constitutes a finished good for sale.
Why is Inventory an Asset?
Inventory is an asset because how fast you turn over your stock and replace it is an indicator of how much your business is worth both now and in the future. In other words—the faster you sell and the more revenue you generate, the more you’re worth.
No company wants to hold onto its inventory for a long time. Why? It’s expensive to store stock, products could perish or become irrelevant in the future.
If you have a business, your inventory is classed as a “current asset” on your balance sheet.
How is Inventory Valued?
There are three ways inventory is generally valued:
- First-in, first-out (FIFO)
- Last-in, last out
- Weighted average
Why is it important to manage your business’ inventory?
Knowing what inventory you have helps you to manage your existing and future overheads. If you hang onto items for too long, it’s costly to store, it risks being damaged, and you might face a decline in consumer demand. If you have a small inventory, you may, however, risk running out of stock and losing out on sales.
Many businesses invest in software solutions that help them manage their inventory in real-time. Such programs are often tailored to meet the needs of specific industry sectors. So, if you’re thinking of purchasing this kind of software, be sure to bear that in mind.
A business will typically take a manual stock check at the end of every accounting period. This is usually every three months and/or once a year before the accounting year ends. Some businesses do a daily inventory. For example, a catering company with a high number of regular covers needs to take a daily inventory to buy in more stock.
When a stock take occurs, if there’s a discrepancy between what’s counted and what’s on your company’s balance sheet, that’s called “shrinkage.” Put simply, it’s inventory that’s missing—be it lost or stolen.
If you have lots of inventory, you can use an approach called “just-in-time.” This means that when you’re making something for sale, you order materials to make that item just in time to meet your customers’ demands. Therefore, you have less inventory and less risk of it sitting around for long periods of time.
If this sounds like a risky strategy, you’re right. However, if you have a good idea of how much you sell, it can work. For example, if you sell handbags and you know you sell 65 per week, on average, and your deliveries occur each Monday, you know how you can keep up with customer demand. The downside is if there’s a slippage in delivery times and/or you sell more/less than anticipated.