For many businesses, inventory is one of the largest items on the balance sheet, so it is important to understand what constitutes inventory. In essence, inventory refers to the stock that a business has on hand – whether that stock is raw materials or a finished product. A more nuanced understanding can be difficult – inventory is not always something that the business has in its possession. Goods in transport and consigned goods may count as inventory, or even goods that are in the procurement process. While finished goods on a warehouse shelf will always be considered to be inventory, stock can be described as inventory in a number of other contexts.
Stock as Raw Materials
Although relatively simple to understand, this form of inventory creates some management challenges. Raw materials are most relevant to manufacturers, who procure them to produce value-added goods. Ensuring that your business manages inventory levels is critical. A major inventory issue for manufacturers is having to shut down the production line because a critical raw material or packaging item is not available. On the other hand, raw materials can take up a significant amount of space and involve significant handling so it is important to manage inventory carrying costs and prevent excess stock from accruing.
Work in Process Items
Although many manufacturing processes are incredibly quick, other items may take longer to produce. Modular buildings, for example, may take days or weeks to assemble. Work in process items are the materials that are have been partially assembled or transformed into a finished product. Inventory management software tools often have a ‘bill of materials’ or ‘assembly’ feature to manage some of the challenges of partially-completed products. Record keeping is of particular importance during the work in process stage, for example, tracking what raw materials went into which batches of finished product (an ‘assembly’) is of critical importance in some food and beverage operations.
In very large businesses, finished goods may be managed by a different department although in smaller businesses they are often kept in the same space and managed by the same people as raw materials and work in process. Some businesses, such as wholesalers, distributors and retailers, may deal almost exclusively in finished goods. Particular challenges involving finished goods include managing obsolescence and managing inventory carrying costs as finished goods often occupy more space than their constituent parts, so costs such as storage and transportation can mount up quickly.
Inventory in transit
Although some businesses do not consider inventory in transit as inventory, doing so is usually prudent. A supplier will typically bear the risk of products damaged in transit and may pay some or all of the cost of delivering orders. Equally, in businesses with multiple stores and warehouses, the inventory available to the business may not always sit on a shelf.
Consignment inventory is essentially inventory that a business holds but which it does not own. For example, designers of boutique products often partner with larger retailers to stock their products with the retailer stocking and selling the product without first purchasing it from the supplier. In this situation, both businesses may treat the product as inventory for some purposes. Legally and financially, a consigned product is part of the consignor’s inventory, although the business that is actually stocking the product will still need to keep track of stock movements and manage inventory carrying costs.