7 Types of Inventory in Accounting and How to Manage Them
Inventory is one of the most important assets for any business that sells goods or uses materials to produce goods. Inventory refers to the items that are either ready for sale or used in the production process. Managing inventory efficiently can help businesses reduce costs, increase sales, and improve cash flow. In this article, we will explain what are the 7 types of inventory in accounting and how to manage them effectively.
Raw Materials Inventory
Raw materials inventory is the inventory of the inputs that are used to create subassemblies, components, or final products. For example, a furniture manufacturer may have raw materials inventory such as wood, metal, fabric, and glue. Raw materials inventory is usually valued at the lower of cost or market value.
To manage raw materials inventory, businesses need to track the quantity and quality of the materials they have on hand and order new materials when needed. Businesses also need to consider factors such as lead time, demand, and supplier reliability when ordering raw materials.
Work in Progress Inventory
Work in progress inventory (WIP) is the inventory of the goods that are partially completed in the production process. For example, a car manufacturer may have WIP inventory such as car frames, engines, and tires. WIP inventory is usually valued at the cost of the raw materials plus the labor and overhead costs incurred so far.
To manage WIP inventory, businesses need to monitor the progress of the production process and ensure that there are no bottlenecks or delays that affect the quality and quantity of the output. Businesses also need to optimize the production cycle time and minimize the waste and scrap generated during production.
Finished Goods Inventory
Finished goods inventory is the inventory of the products that are ready for shipping or selling. For example, a clothing retailer may have finished goods inventory such as shirts, pants, and dresses. Finished goods inventory is usually valued at the cost of production or the market value, whichever is lower.
To manage finished goods inventory, businesses need to forecast the demand for their products and adjust their production and ordering accordingly. Businesses also need to balance the inventory levels and avoid overstocking or understocking their products. Businesses also need to implement quality control measures and handle returns and exchanges efficiently.
Merchandise Inventory
Merchandise inventory is the inventory of the goods that are purchased from suppliers and resold to customers without any modification. For example, a bookstore may have merchandise inventory such as books, magazines, and stationery. Merchandise inventory is usually valued at the cost of purchase or the market value, whichever is lower.
To manage merchandise inventory, businesses need to analyze their sales history and customer preferences and order the right products at the right time and quantity. Businesses also need to negotiate favorable terms with their suppliers and take advantage of discounts and incentives. Businesses also need to display their products attractively and promote them effectively.
Maintenance, Repair, and Operating Supplies Inventory
Maintenance, repair, and operating supplies (MRO) inventory is the inventory of the items that are used to support the production or operation of the business but are not part of the final product. For example, a factory may have MRO inventory such as tools, lubricants, spare parts, and cleaning supplies. MRO inventory is usually valued at the cost of purchase.
To manage MRO inventory, businesses need to estimate their usage and consumption of these items and order them as needed. Businesses also need to store these items securely and accessibly and keep track of their expiration dates and warranties. Businesses also need to maintain their equipment and facilities regularly and prevent breakdowns and malfunctions.
Consignment Inventory
Consignment inventory is the inventory that is owned by a supplier but stored by a retailer until it is sold to a customer. For example, a jewelry maker may have consignment inventory such as earrings, necklaces, and bracelets that are displayed by a boutique until they are purchased by a customer. Consignment inventory is usually valued at zero until it is sold.
To manage consignment inventory, businesses need to establish clear agreements with their suppliers regarding the ownership, pricing, payment, and return policies of these items. Businesses also need to monitor their sales performance and provide feedback to their suppliers on customer preferences and trends. Businesses also need to protect these items from theft, damage, or loss.
Decoupling Inventory
Decoupling inventory is the inventory that is used to buffer against uncertainties or fluctuations in supply or demand. For example, a restaurant may have decoupling inventory such as frozen food, canned food, and bottled drinks that can be used in case of an unexpected surge in customers or a delay in delivery from suppliers. Decoupling inventory is usually valued at the cost of purchase or production.
To manage decoupling inventory, businesses need to analyze their historical data and identify the sources and patterns of variability in their supply chain or market. Businesses also need to determine the optimal level and location of these items and adjust them according to the changing conditions. Businesses also need to review their inventory periodically and dispose of any obsolete or excess items.
Types of Inventory in Accounting
Inventory is the term used to describe the goods that a company has in stock for production or sale. Inventory is one of the most important assets of a company, as it represents the source of revenue and earnings. There are three main types of inventory in accounting: raw materials, work in progress, and finished goods.
Raw Materials
Raw materials are the inputs that are used to create subassemblies, components, or final products. For example, a furniture manufacturer may use wood, metal, fabric, and glue as raw materials to make chairs, tables, and sofas. Raw materials are usually purchased from suppliers and stored in warehouses until they are needed for production. The cost of raw materials is recorded as an asset on the balance sheet until they are used or sold.
Work in Progress
Work in progress (WIP) are the goods that are partially completed in the production process. For example, a car manufacturer may have engines, chassis, and doors as work in progress inventory. Work in progress inventory represents the value of the labor and materials that have been invested in the unfinished products. The cost of work in progress is also recorded as an asset on the balance sheet until they are completed or sold.
Finished Goods
Finished goods are the products that are ready for shipping or selling. For example, a clothing retailer may have shirts, pants, and dresses as finished goods inventory. Finished goods inventory represents the final output of the production process and the potential revenue for the company. The cost of finished goods is also recorded as an asset on the balance sheet until they are sold or delivered to customers.
Global Demand for Inventory
The global demand for inventory depends on various factors, such as consumer preferences, economic conditions, technological changes, and competitive forces. The demand for inventory can increase or decrease depending on the market situation and the industry sector.
Increasing Demand
Some factors that can increase the demand for inventory are:
Rising consumer income and spending
Growing population and urbanization
Expanding e-commerce and online shopping
Innovation and product differentiation
Seasonal or cyclical fluctuations
For example, the demand for inventory in the electronics industry may increase due to the launch of new products, such as smartphones, laptops, and tablets. The demand for inventory in the fashion industry may increase due to changing trends, styles, and seasons.
Decreasing Demand
Some factors that can decrease the demand for inventory are:
Declining consumer income and spending
Shrinking population and aging
Increasing competition and price wars
Obsolescence and product substitution
Regulatory or environmental restrictions
For example, the demand for inventory in the automotive industry may decrease due to the emergence of alternative modes of transportation, such as electric vehicles, bikes, and public transit. The demand for inventory in the food industry may decrease due to health concerns, dietary preferences, and ethical issues.
References:
http://publications.cta.int/media/publications/downloads/1749_PDF.pdf
https://web.archive.org/web/20100425054824/http://www.bsu.edu/web/scfrazier2/jit/mainpage.htm
http://www.italiannotebook.com/local-interest/parmigiano-hedge/
(https://www.investopedia.com/terms/i/inventory.asp)
