Supply chains cannot function without managed inventories. Efficient inventory optimization can protect you against demand and supply variations and help to reduce overall costs. A significant reason for the success of many manufacturing businesses is that they optimize inventory well. This blog will help you understand the importance of inventory optimization, the tools that can be used for it, and the detailed process required.
What Is Inventory?
Inventory is the stock of goods or any other items and components that a business needs to buy and store for reselling, manufacturing, or other intermediate activities. For business success, every company needs to ensure that it has enough inventory to meet the demand of customers.
A business has to deal with raw materials as well as finished products. Inventory is a common term used in the context of manufacturing industries, but it is not limited to just one segment. In simplified terms, inventory is the current asset that comprises all the finished items as well as raw materials. Therefore, it may include items that are meant for sale and also those not meant for sale. The condition of the items is also significant when managing inventory.
Despite the fact that we refer to any asset on the balance sheet as inventory, it is not desirable to have an excessive amount of inventory. Every business has got a balance sheet that incorporates the term, inventory, and its different types. The type of inventory may vary based on the industry.
Now that we know what is inventory, we will discuss the different types of inventory and their features.
Types of Inventory
This segment highlights five major classifications of inventory.
Raw materials
Raw materials are the most important requirement for a business to produce finished products. The company can directly produce this raw material or source it from another supplier. Based on it, this category is classified into direct raw materials and indirect raw materials.
1. Direct raw materials: These comprise the products that are directly used in the manufacturing of the final product. Examples of direct raw materials include:
- Steel for manufacturing cars
- Fabric for making clothing
- The wood used in the manufacturing of furniture
2. Indirect raw materials: A business will not use indirect raw materials while producing the final product. These are also termed long-term assets of an organization. These materials are used to support or facilitate the manufacturing process but are not directly visible in the finished product.
Examples of indirect raw materials include:
- Fuel for operating manufacturing equipment
- Packaging materials for storing and shipping finished products
Work-in-progress inventory
This inventory signifies the products that are partially completed and are in the process of manufacturing. In simple terms, it refers to semi-finished products at different stages of production. One of the easiest ways to explain this type of inventory is the assembly line of the car. The partially assembled car on the production line is the WIP inventory.
WIP inventory can help manufacturers track the progress of production and manage their resources effectively. However, it can also tie up valuable capital and resources, so it's important to manage it carefully.
Finished items
The finished goods inventory will consist of products that are ready to sell. The categorization of finished goods depends on the workflow of your business. A make-to-stock workflow will require you to store the inventory until you receive an order.
On the other hand, a make-to-order workflow will consist of creating the final product only when the order is received and keeping it ready before its shipment to the customers.
MRO (Maintenance, Repair, Operations)
In case you want to run your factory smoothly, then this inventory is imperative for you. It includes materials and supplies used in the maintenance and repair of production equipment and facilities. MRO inventory is integral for every business for the seamless functioning of the production division. You may need to access this inventory anytime; a disjointed MRO inventory management may lead to equipment failure, thus leading to costly downtime and repairs.
The goal is to ensure that the right MRO supplies are available when and where they are needed while minimizing the cost of holding excess inventory. MRO inventory examples include spare parts, lubricants, tools, and others.
Decoupling inventory
It refers to the process of separating the production process into different stages. This helps in better control over the flow of materials between them. It ensures that the production process remains flexible and adaptive to changes in demand while minimizing the amount of inventory required to support the process.
Inventory Examples
Next, let's dive deeper and look at some examples of each inventory category:
Raw materials
Raw materials can be considered to be resources that are available in pieces and assembled for manufacturing the final product.
- For example, while making shoes, the raw materials used will be cotton and rubber.
- The manufacturers of windows make use of sheet glass and glue as raw materials.
- Bread is prepared from raw materials like butter, flour, and yeast.
- Sugarcane can be considered to be the raw material for the manufacturer of sugar.
- Wood is used as raw material for creating wooden furniture.
Work-in-progress (WIP) inventory
- Stacks of paper manufactured and sized correctly are examples of WIP inventory for the assembly of writing diaries.
- Moreover, one can also consider bread dough to be a WIP inventory for a company manufacturing bread since it will help to prepare the bread.
- In case you are running a furniture business, there will be unfinished components before getting to the finished product. For example, drawers are the WIP inventory of a storage cupboard.
Finished goods
Finished goods are prevalent in the majority of the businesses out there that are selling items to their customers.
- In case you are running any restaurant, then the food items that you are serving to your customers can be considered to be finished goods.
- A piece of furniture on display at an outlet is an example of a finished product available to customers for purchase.
Maintenance, repair, and operating supplies inventory
- Lubricants like oil and grease.
- Spare parts like gears, bearings, and motors are used for replacement during maintenance or repair.
- Tools, such as wrenches, screwdrivers, and pliers.
Decoupling Inventory
- Raw materials buffer stock
- Work-in-progress buffer stock
- Finished goods buffer stock
What Is Manufacturing Inventory?
This particular inventory is also referred to as the product inventory. It is not possible to manufacture items without the help of materials and supplies, which are known as manufacturing inventory.
Wholesalers and retailers have merchandise inventory, while a manufacturing business has got manufacturing inventory. In this case, the goods are prepared in various phases of production until they are prepared for shipment.
Importance of Inventory Control
Discussed below are the most important benefits of inventory control:
- One does not face any problems of running short of stock or having excessive stock.
- With better inventory control, businesses can comprehend the exact requirements of customers, and this will help them to save the cost of storage in the long run.
- All items will be stored and organized in a particular place which can play an important role in saving time for workers. This is because there is no need for them to waste any time searching for the materials.
Inventory Best Practices
Inventory management and inventory control are crucial to ensure you have complete control over the flow of stocks for meeting customer requirements. Following the best inventory management practices can help in gaining a competitive edge. Here are some of the best practices that will help in the same:
Demand forecasting
In this process, businesses can evaluate trends and historical information for the purpose of predicting the required levels of inventory for the future. This helps in fulfilling all customer requirements accurately.
Inventory management system
This kind of system allows companies to perform inventory monitoring as well as order fulfillment. This is done by monitoring all the products entering the company and also exiting at the time of production, distribution, and storage. An ERP system with an inventory module can help streamline the supply chain process and also keep track of stock.
Batch tracking
By the term batch, we refer to certain products created with identical materials and also at identical times. Batch tracking is utilized for monitoring the commodities and products efficiently by tracing batch numbers via the distribution chain.
Data analysis
Regular analysis of inventory data is integral for businesses. It helps identify the trends and patterns in demand, which can be used to optimize inventory levels and improve production efficiency.
What Is the Inventory Process?
The inventory process is the end-to-end journey from production to shipment with the help of an inventory management process. It is important to monitor and control the stock of your business throughout the inventory process. The primary objective of this process will be to make sure that it is possible to get the proper amount of stock at all times and maintain buffer inventory or cycle inventory as needed. The inventory process can play a major role when it comes to the financial health of any business.
What Is Inventory Count?
Inventory count is the updated number of stock items in possession of the business. It refers to the process of calculating and reconciling the actual physical inventory with the inventory records in the company's system. This process should be performed every year and will assist you in evaluating your debts as well as assets. Inventory count supports the business to verify the items present in the warehouse or inventory physically as well as their present condition.
Inventory count also enables a business to comprehend how much raw material stock it has got as well as how many finished goods assets. The inventory counting process can be executed manually, or you can also adopt new technologies like automated barcode scanning.
Methods of Recording Inventory
While recording inventory, we are concerned about recording the stock's physical quantity along with its valuation. You will come across two methods of recording inventory, namely, the periodic and perpetual inventory systems. The perpetual inventory system implies that it will be imperative to record inventory once raw materials and final products have been issued or purchased. On the contrary, in the case of a periodic inventory system, it is the actual inventory physical count on any particular date when the verification of inventory is performed.
What Is Inventory Turnover?
It implies the number of days elapsed between the purchase of an item by any business and the marketing of the item. It is the rate at which a business sells or replaces different products or product categories. Here's the formula for calculating inventory turnover:
Inventory Turnover = Cost of Goods Sold (COGS) / Average Inventory Value
Where:
COGS = Cost of goods sold during a specific period of time.
Average Inventory Value = The average value of inventory held over the same period of time, calculated as: (Beginning Inventory Value + Ending Inventory Value) / 2.
After understanding what is inventory** **and other related concepts, let's know about inventory analysis.
What Is Inventory Analysis?
By the term inventory analysis, we refer to the method of assessing and validating inventory data to determine the optimum stock quantity that should be carried by the company. Inventory analysis helps to keep up with customer demands while controlling expenses and enhancing sales, by getting a succinct picture regarding the inventory that is responsible for generating profits for the business.
There is no need to have any complicated data infrastructure to take advantage of the inventory analysis benefits. You simply need to comprehend the formulas of inventory analysis while having a solid grasp of the principles of inventory analysis. For instance, a contractor can utilize inventory analysis to verify whether there are enough materials for the business to undertake a fresh project.
Benefits of Inventory Analysis
Following are the key benefits of inventory analysis:
Improves the flow of cash
Inventory represents a significant amount of cash allocation for various manufacturing businesses every month. It will be quite difficult to operate any business successfully in case there is no effective method for inventory analysis.
Satisfies customers
Inventory analysis will help you to respond to your customers within a short span of time while filling orders effectively. This will help you to get satisfied and dedicated consumers in the long run.
Minimizes project delays and stockouts
At times, you will come across some businesses that undertake projects needing numerous items. In this case, there might be some project delays because of stockouts which can be enough to frustrate the customer. However, the good thing is that inventory analysis will help you to minimize stock-outs as well as project delays in the best possible way.
What Is Demand Forecasting?
Demand forecasting is the procedure of predicting and forecasting consumer demand for any particular service or product by relying on the predictive investigation of historical information. In this way, businesses can make informed decisions regarding supplies and also forecast the total sales as well as revenue for the near future.
Accounting for Inventory
Our subsequent discussion on the topic of what is inventory will be 'accounting for inventory'. It implies comprehending the exact quantity of units for ending inventory while allocating a value to all those units. Following this, the resultant expenses will be utilized for recording an ending inventory value plus assessing the prices of the items for that reporting period.
What Is Average Inventory Cost?
Average inventory cost refers to the average cost of inventory for a particular span of time or across two or more financial accounting periods. It is a measure of the cost of inventory that a company holds over a specific period of time, usually one year or two years. Average inventory cost helps to compare the cost of inventory to be sold at any specific time or location.
Average inventory cost is calculated as below:
The total cost of inventory / Average quantity of inventory held during the same period
The process of calculating average inventory cost uses the weighted average of every single inventory item bought during a particular span of time. It assigns value to the expenses of items marketed plus the price of products that have not been sold till now.
Follow Inventory Best Practices
It's important to have a proper inventory control system for a business to be successful. One must focus on the demand and supply throughout the inventory workflow to get the best results when it comes to running a business smoothly.
Now that you know what is inventory, methods of recording inventory, inventory analysis, demand forecasting, and average inventory cost, you must implement inventory management best practices to reap numerous benefits like increased sales and turnover.
For this, digitize and transform your SME manufacturing businesses by implementing TranZact today! This centralized, cloud-based tool provides advanced ERP solutions and more to help you take your business to new heights of success. It also offers barcode scanning features for automated inventory updating and tracking. Thereby, helping businesses to gain enhanced inventory control and maximize inventory efficiency.
FAQs on Inventory
1. What is the inventory process?
The inventory process indicates the method of ordering, using, storing, as well as marketing the inventory of a company. This consists of the management of components, raw materials, as well as finished products.
2. How is inventory controlled?
Inventory control includes the procedures that ensure that the required supply of inventory is maintained within a company. This will help the business to satisfy the demands of the customers without going out of stock. Inventory control procedures include warehouse management and supervision activities to ensure the business can get the most out of its inventory. With inventory control practices a business can improve its bottom line significantly.
3. What is the need to do inventory management?
For a business to run profitably, it must focus on existing and new customers. Customers stick around only when their demand is met with a constant supply of finished goods. So to meet the demand, businesses must maintain a seamless supply. This is where inventory management comes in.
