What Is Inventory? Its Definition, Types, and Examples

What Is Inventory? Its Definition, Types, and Examples
What Is Inventory? Its Definition, Types, and Examples

What is Inventory?

Inventory includes both raw materials needed in production and finished commodities for sale. A company’s inventory is one of its most valuable assets because inventory turnover is one of the key sources of revenue generation and subsequent earnings for the company’s shareholders. There are three sorts of inventory: raw materials, work-in-progress, and finished goods. It is classified as a current asset on a company’s balance sheet.

NOTE

Inventory includes both raw materials utilized in the production of goods and finished goods for sale.

It is recorded as a current asset on a company’s balance sheet.

Inventory is classified into three types: raw materials, work-in-progress, and finished goods. 

Inventory is appraised using one of three methods: first-in, first-out; last-in, first-out; or weighted average.

Inventory management enables organizations to reduce inventory expenses by producing or receiving items on an as-needed basis.

Inventory is a valuable asset for every firm. It is defined as the collection of items utilized in production or finished goods held by a corporation in the ordinary course of business. Inventory is divided into three categories: raw materials (any resources used to manufacture completed goods), work-in-progress (WIP), and finished goods (those ready for sale).

As previously stated, inventory is classed as a current asset on a company’s balance sheet, acting as a buffer between manufacturing and order fulfillment. When an inventory item is sold, its carrying cost is moved to the cost of goods sold (COGS) category on the income statement.

Inventory can be appraised in three different ways. These methods are:

  • The first-in, first-out (FIFO) technique states that the COGS is calculated using the cost of the earliest purchased components. In contrast, the carrying cost of the remaining inventory is based on the cost of the most recently purchased materials.
  • The last-in, first-out (LIFO) approach. According to this method, the COGS is evaluated using the cost of the most recently purchased resources, while the value of the remaining inventory is based on the earliest purchased materials.
  • The weighted average technique entails valuing both inventories and COGS using the average cost of all materials purchased during the period.

Special Considerations 

Many producers work with retailers to consign inventory. Consignment inventory refers to inventory owned by a supplier/producer (usually a wholesaler) but kept by a client (usually a retailer). The client then purchases the inventory after it has been sold to the final customer or consumed (for example, to make their own products).

The supplier benefits from the customer promoting their product and making it readily available to end consumers. The consumer benefits from not having to expend capital until it becomes beneficial for them. This means they only buy it when the end user buys it from them or when they use the inventory in their operations.

Types of Inventory

Remember that inventory is typically divided into three categories: raw materials, work-in-progress, and finished goods. The IRS defines items and supplies as extra inventory categories.

Raw materials are unprocessed materials utilized to make a product. Examples of raw materials are:

  • Car manufacturing uses aluminum and steel.
  • Flour for bakers that make bread.
  • Refineries hold crude oil.

Work-in-progress inventory consists of partially finished goods that are waiting to be completed and resold. WIP inventory is often referred to as inventory on the manufacturing floor. 

A half-assembled airplane or a partially constructed boat is sometimes referred to as work-in-process inventory.

Finished goods are things that have gone through the manufacturing process and are now available for sale. Retailers often refer to this inventory as merchandise. Electronics, clothing, and automobiles are common types of merchandise stored by shops.

Inventory Management

Keeping a large volume of inventory on hand for an extended period of time is generally not a good idea for a firm. This is due to the issues it provides, such as storage costs, spoiling expenses, and the risk of obsolescence.

Having too little inventory also has its drawbacks. For example, a corporation faces the danger of losing market share and earnings from future sales.

Inventory management forecasts and tactics, such as a just-in-time (JIT) inventory system (including backflush costing), can assist businesses reduce inventory expenses by producing or receiving products only when they are needed.

It’s usually a good idea for businesses to invest in an effective inventory management system. This is especially true for larger companies with several sales channels and storage facilities. These systems can identify waste, low turnover, and fraud/robbery.

Inventory Turnover

Inventory turnover is a critical component of inventory management. This indicator, also known as stock turnover, tracks how much and how frequently a company’s inventory is sold, replaced, or used. This figure shows how profitable a company is and whether any inefficiencies need to be addressed.

Consumer demand is a vital factor that determines whether inventory levels will shift quickly or not at all. Higher demand often indicates that a company’s items and services will move swiftly from the shelves to consumers’ hands, whereas low demand frequently results in a slow turnover rate.

A company’s inventory turnover is frequently stated as a ratio. The inventory turnover ratio is computed using the following formula:

Inventory ratio is calculated by dividing cost of goods sold by average inventory value.

This statistic can be used by company management to make key decisions such as whether to continue manufacturing specific products and services or whether to handle difficulties that arise.

What is Inventory?

Inventory refers to a company’s ready-to-sell goods and products, as well as the raw materials needed in their production. Inventory can be divided into three categories: raw materials, work-in-progress, and finished goods.

Inventory is classified as a current asset in accounting since a company normally expects to sell the finished products within a year.

Inventory can be valued using last-in, first-out, first-in, first-out, or the weighted average technique.

What is an example of an Inventory?

A common example of an inventory is a retail store stock of merchandise, which includes items such as clothing, electronics, and accessories for sale to customers.

What Does Inventory Tell Us About a Business?

The rate at which a company’s inventory turnover changes is one way to assess its performance. When a corporation sells items faster than its competitors, it incurs lower holding costs and opportunity costs. As a result, they frequently outperform, increasing the efficiency of their product sales.

Conclusion 

Inventory provides firms with materials to keep operations running. This comprises any raw materials required for the manufacture of goods and services, as well as any final commodities sold to customers on the market. Managing inventory and calculating turnover rates can help businesses understand how effective they are and where they can pick up the slack when profits start to dry up.