The business’s inventory management and inventory controls are critical measures in the business operations as the inventory of products is where the business derives its income from. But first we need to discuss the basic points about inventory to be able to understand.
Definition of Inventory
In business accounting, inventory is the goods or products that the business handles with the intention of selling them for profit. Inventory may be tangible or intangible. Tangible inventory may be raw materials used to manufacture the goods to be sold by the business or ready-made products that are procured from suppliers or vendors, also with the intention of selling them for financial returns for the business. If you are selling software, licenses, or other similar goods, are classified as intangible inventory.
Types/Classification of Inventory
It is important to know the types or classifications of inventory to be able to make sound financial and production planning decisions for the operations of the business. Knowing the type of inventory is also important in coming up with a solid inventory management and inventory control procedures for the business.
1. Inventory in Retail/Merchandising Business
These are the goods that are ready to use and sell to customers for a profit. In your business’s financial statements, particularly your current assets, this would just appear as “Merchandise Inventory” or simply “Inventory” in your books of accounts.
2. Inventory for Manufacturing Business
For businesses who manufacture goods for retail or sale to merchandising businesses, you would typically have three more types under this umbrella category of inventory and all of which are reported in the current assets section of the business’s balance sheet at the end of an accounting period.
Raw Materials Inventory. This is the basic cost of the material that you are going to process and convert into a product or the final finished goods. Example: Steel – for roof manufacturers or car manufacturers. Wood – for pieces of furniture.
Work-in-Process Inventory. These are the unfinished units at the end of an accounting period.
Finished Goods Inventory. These would be the completed units of manufactured goods but are yet to be sold.
Some manufacturing companies maintain a fourth inventory account in their books and that would be the Manufacturing or Factory Supplies Inventory Account used to account for the basic raw materials that are to be processed but are not necessarily essential in the manufacturing of a certain product. As with the three other inventory accounts above, this is also reported in the balance sheet of the business at the end of the accounting period. Examples of which may be glue, packaging materials, nails, and other similar items.
3. Maintenance, Repair, and Operating (MRO) Goods
This is the third type of inventory that may or may not be included in the books of accounts. This is simply the inventory that the business has in support of the manufacturing process.
Simply put, inventory management tracks and controls all stocks from the moment you purchase them from your suppliers, placing them into your warehouse, and eventually selling them to your customers. Inventory management is the foundation and a fundamental aspect that a well-functioning business must have, especially if you are aiming for success and a secured place in the world of retail business.
Five Stages of the Inventory Management Process
This simply means purchasing needed materials for the production or manufacturing of your goods to be sold or purchasing the ready-made goods or merchandise from your suppliers or vendors for sale to your existing and new customers.
Creating your products to be sold from your raw materials and/or component parts. This is only for businesses involved in manufacturing products and goods. Merchandisers and wholesalers normally skip this step but is essential with businesses involved in manufacturing.
3. Holding Stock
This usually involves storing your raw materials before manufacturing (if and as required) and your finished goods or ready-made goods before they are sold.
Being able to sell your stocks or goods to your customers and having them pay promptly for it.
The reports from a particular accounting period or at the end of it would keep business owners up to date and up to their toes when it comes to sales or lack of it. Inventory reports are needed in order to check if the business is making or losing money or what should be addressed if the reports would yield concerns and findings.
Basically, inventory control is the process by which a business manages its stocks in storage. What it involves is knowing how much you have available, where it is located, and the conditions of your stocks in hand. Inventory control is also about being able to put your stocks properly and efficiently in storage because even this aspect has an impact on inventory costs. The time you spend controlling and counting is also a determining factor with regard to inventory costs as well.
Inventory Management versus Inventory Control
Both concepts are important and look similar. However, the takeaway here is that inventory control is a key part of inventory management.
Importance of Inventory Management
Inventory management is essential in ensuring that you can run effectively and efficiently your business, that you know how to handle your customers and their demands, and that you are meeting your targets when it comes to sales and income for the business.
- Ensure smooth business operations
Having a good and solid inventory management system or plan ensures that you will be able to run your business smoothly and efficiently. Inventory management is crucial to business operations so it will not crumble or fall apart.
A business owner needs to keep in mind the following aspects of this benefit of having a working and efficient inventory management system:
- The business owner and its warehouse staff should know and be able to know how to match their product supplies to the customers’ demands
- When you know the effects of having stock outs or out-of-stock situations, there is already a contingency plan in place to avoid this. Having a proper supply and demand forecast for business operations would help avoid these situations.
- Know when to implement changes, if needed, to inventory controls that are in place if the situation is not working out well for the business.
- Keeping your customers happy
Keeping your customers satisfied, happy, and loyal also entails having enough stocks of the products that you are offering to them. At any given period in the course of business operations and financial reports generated from the inventory that you have, inventory managers and controllers should already know the trends and seasons that have a great effect on the products offered to your customers and to the business’s sales and income as well. Knowing that you have enough stocks, you can replenish fast moving items on time, knowing which products should be re-evaluated for failure to rake in sales, recommending possible changes in purchases, all have an effect in keeping your customers happy. Inventory controllers and managers should not just focus on keeping stocks effectively and efficiently moving, they should also work together with marketing and business development to weed out products that are not helpful in generating sales and probably replace them with ones that would.
- Growing your company with inventory management
Inventory management helps companies to grow by also being able to identify suppliers and vendors that work well together with your business’s inventory schedule and marketing and sales targets. Are your suppliers able to meet your demands? Do they have other products that could well be worth being placed in your target market? Will your current and succeeding inventory purchases help grow your business in terms of sales and income? Inventory management should not just be concentrated in ensuring that stocks are available. It can also help grow and branch your business out to other ventures that will be beneficial in the long run.
Latest Inventory Management Techniques
Just like in any other business aspect, procurement, supply chain management, logistics, and inventory management have come a long way from how they started. These business concepts have been integral in any business and being knowledgeable and up to date about the latest trends and developments is vital to ensure that your business will be at par with the changing times.
A significant increase in e-commerce businesses have paved the way for a change in inventory management techniques. Although the most common inventory management techniques are still being employed by traditional businesses, it is not wrong to introduce new and updated concepts especially if it could help the business operations run smoothly and efficiently. Mixing these techniques may be a trial-and-error process but once you are able to strike a good balance, it could put your business in a much better position in terms of market share and income to your business operations.
1. Just-in-Time Inventory (JIT)
This inventory management technique involves just the right amount or as little stock as possible to mitigate costs and risks involved in keeping a large number of stocks in your warehouse on hand. This inventory management technique allows companies to just order what they need in consideration of their production volume and allows them to fully utilize every raw material and component with minimal wastage and losses.
This inventory management system is preferred by some of the biggest manufacturers in the world such as Dell Computers and Toyota. Inventory is simply ordered and shipped as and when needed. As we are well aware of, inflation rates and other economic factors dynamically have an effect on these industries, so it is wise to be on the safer side and apply a more conservative approach in terms of manufacturing, stocking, and shipping of these types of items.
You may have heard of this term especially to those who are engaged in e-commerce businesses or those who are online retailers. Simply put, businesses who employ this inventory management technique are outsourcing all aspects of managing their stocks or goods. It is currently one of the more popular inventory management techniques and solutions for businesses who would not want to deal with supply chain, inventory control, and logistics concerns. For one, this is beneficial especially to those businesses who have limited space in which they can place their goods. Dropshipping partners send out regular reports to the business owner as to the status of their goods thereby helping the business identify “problematic” items and items that are fast moving and are essential in the generation of sales for the business.
Dropshipping allows the online retailers or e-commerce businesses to focus their efforts, capital, and resources on the business’s marketing and sales platforms to gain more customers and reach their targeted sales for the period.
One of the drawbacks of dropshipping would be having to rely so much on the outsourced service that may compromise the quality of your goods for sale. It is important that the business owner must still assign one or two key personnel to ensure that the required standards are met and that the dropshipping partner is also employing inventory management and controls that are acceptable and at par with the standards agreed upon.
Also, transacting in bulk using drop shipping partners or services may seem like the business is saving a lot in terms of cost. A business owner should consider looking into its profit margins because since one is still dealing with transactions at a retail level, the profit margin may get eaten up by costs charged by dropshipping partners. In terms of customer service, the business owner still bears customer service-related concerns and complaints that may be brought about by mishandling of packages and products by the dropshipping partner.
3. Safety Stock
This is an inventory management technique used to prevent stockouts due to incorrect or inaccurate forecasting and unforeseen circumstances that are sometimes beyond the control of the business owner. Extra inventory is ordered beyond what is the current demand.
Also known as buffer stock, this inventory management technique is used to allow businesses to have enough in cases when the demand is high, and the suppliers will not be able to meet the demand at that certain instance. It is important for businesses, especially with fast moving items, to regularly have a safety stock in hand to ensure customer satisfaction and meet their demands at any given time.
4. First-In, First-Out/Last-In, First-Out (FiFO/LIFO)
This is one of the most conventional inventory management techniques known to businesses. These are basic methods used to calculate the cost of goods sold by the companies.
First-In, First-Out simply means that stocks that arrived and were stored first should go out first. With Last-In, First-Out, stocks that arrived and were stored last should be the stocks that need to go first.
The oldest inventory goes out first in the FIFO system and the newer inventory (LIFO) is prioritized in this inventory management technique. FIFO keeps your inventory fresh while LIFO prevents your stocks or inventory from going bad.
As with all other inventory management techniques, there are benefits and disadvantages to both. Most businesses still prefer to use the FIFO system to prevent older inventory from getting stuck in the warehouse or storage. It is still so much better to sell the older stocks on hand so that fresher and newer stocks may come in soon. LIFO is not always practical for most businesses due to these reasons.
5. Reorder Point
It is important for the reorder point to be identified as part of a beneficial inventory management system for businesses. The reorder point is defined as the minimum quantity or unit that a business should have in their stock or inventory before having the need to place another order for that specific item. The reorder point is typically higher than that of the safety stock numbers because this inventory management technique must factor in lead time for the processing of the order.
As with other inventory management systems, this technique prevents the business from having stockouts, especially of fast moving and in demand items, and it also ensures that there will be no unnecessary inventory pile up in your stockroom or warehouse, thereby avoiding unnecessary costs to the business operations for the period.
6. ABC Analysis
Basically, this inventory management technique classified into tiers your items or goods that are for sale and what brings in the most profit and the least from among all of them. With this type of inventory management technique, companies and businesses are able to have better inventory controls especially with their highly valued inventory items. This technique also helps to identify which would need reduction in costs or losses and to also be able to see where to improve on in terms of stock availability.
Inventory management is a dynamic concept in the realm of business especially with the flourishing of e-commerce businesses and online retailers. To keep up with the demands of the changing times, some of these conventional concepts have also been made to adapt to changes in the business scene but still keeping up with the known and accepted accounting standards governing it. Inventory managers should be able to make the proper recommendations to the business owners to reduce unnecessary costs and have better profit margins and increased sales with the right application of these inventory management techniques suited for the business.
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