In this article, learn about:
The five types of inventory
How they affect cycle inventory
Where businesses may store inventory
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Inventory is the collection of goods or materials a business holds for eventual sale. Also known as stock, inventory can include finished products ready for sale or the materials used in manufacturing.
Effective inventory systems are crucial for tracking and managing inventory in any business. Inventory processes are vital to a business's bottom line because they often include both finished products and pipeline materials.
The five types of inventory are:
Raw materials
Work-in-progress (WIP)
Finished goods
Maintenance, repair, and operating (MRO)
Packing materials
By classifying inventory into these categories, businesses can better manage their stock, ensuring that each type of inventory is adequately tracked and maintained. Understanding the differences between the five types of inventory is essential for effectively managing and storing goods.
Raw Materials Inventory
Raw materials inventory is what it sounds like—the primary materials used to make a finished product. Suppliers may purchase this type of stock from another company or produce it directly.
There are two types of raw materials inventory:
Direct Raw Materials: These comprise the various parts of the final product.
Indirect Raw Materials: These materials do not appear in the finished product but are consumed during production.
For example, a furniture-making company might have a stock of raw wood purchased from a supplier. The wood itself is their direct raw materials inventory. Any disposable tools, cleaning products, fuel, etc., would be considered indirect raw materials.
Related Reading: Sourcing in the CPG Industry
Work-in-Progress Inventory (WIP)
Work-in-progress (also called work-in-process) goods are any product that is partially through development. WIP also includes everything that is in use during production. Raw materials are part of the raw materials inventory while they’re sitting on a shelf waiting for use, but become part of the WIP inventory when in use.
WIP inventory is counted as an asset and has accounting entries in a company’s general ledger.
In the furniture-making company example, WIP inventory is anything used during the process of making the furniture, such as the wood and tools used in building a piece of furniture (previously categorized as raw materials). Once the furniture is complete, it moves out of WIP inventory and into finished goods inventory.
Related Reading: What Is Aggregate Inventory Management?
Finished Goods Inventory
Finished goods inventory encompasses the products that are complete but not yet on the retailer’s shelves.
Finished goods inventory can be produced from raw materials and work-in-progress materials, or a company might purchase them.
In accounting, finished goods are combined with raw materials and WIP inventory to produce the complete inventory line. Finished goods are short-term assets, assuming that the supplier can sell them reasonably quickly.
Inventory turnover is a key metric that measures how frequently a company sells or uses its inventory within a specific timeframe, revealing insights into inventory management efficiency.
Maintenance, Repair, and Operating Inventory (MRO)
Maintenance, repair, and operating inventory (MRO) is a critical function of manufacturing companies or factories. MRO refers to anything that helps keep the entire operation running smoothly. MRO inventory could include tools or machinery parts, office supplies, computers, industrial equipment, or employee uniforms.
In the example with the furniture maker, MRO would be machinery, tools, safety equipment, etc.
Suppliers often overlook MRO, and it doesn’t make every list of the main types of inventory. However, MRO is critical to track and manage. One faulty piece of machinery could sideline the whole manufacturing line. If the manufacturer doesn’t have a replacement part on hand, the loss in productivity over time could be considerable.
Companies must regularly replenish MRO inventory to keep a business operating at total capacity. Here are a few best practices:
Identify critical processes: Suppliers should understand which processes are most critical to their business function and how quickly their resources are used. Businesses should ensure they have a plan for maintaining essential pieces of stock.
Increase efficiency: Larger businesses need to audit their operations and processes and ensure there are no inventory overlaps. They should also remove outdated or unnecessary items from their MRO inventory.
Define seasonality: For most businesses, inventory can fluctuate based on the season. Busy or high-production seasons will need a higher stock, and slower seasons will require lower stock. It is essential to document a forecast of these high and low seasons.
Use an inventory management system: Multiple teams may need the same MRO materials. Companies don’t want everyone buying the same thing from other suppliers or at additional costs. Centralizing inventory management helps avoid these issues.
Packing Materials Inventory
Packing materials inventory includes any products or items used to pack or package a finished product, such as boxes, bubble wrap, and shipping materials. Packing materials can also include things like casings, toothpaste tubes, etc.
As with MRO, packing materials inventory is a common place to experience waste. Companies need to have a sound inventory management system and centralized ordering and tracking in place to eliminate the potential for waste among the various types of inventory.
Primary packing material, which directly encases a product for retail display, is crucial for product visibility and consumer access at retail locations.
A Note on Cycle Inventory
All five main types of inventory can be categorized as Safety Stock and Cycle Stock Inventory. Cycle stock is the combined inventory of goods that the company will use and sell. Safety stock is essentially back-up inventory, in case of an unexpected increase in demand.
Related Reading: What Is Stock Control?
Where Do Businesses Store Inventory?
Businesses can store their inventory in any of the following locations:
Display shelves or showroom floor
Storeroom
Warehouse
Transit vehicles
These storage locations can be within the business itself, or the company can outsource to a third-party logistics company (3PL).
Additionally, 'transit inventory' refers to inventory that is currently being transported between various stages of supply chain operations. Managing transit inventory is crucial due to its impact on overhead, transportation, and carrying costs, especially for companies that import components.
Conclusion
Inventory management is critical to successful operations and increasing profit margins.
Average inventory is a key metric in inventory management, calculated to measure inventory efficiency and turnover rates, helping to interpret inventory turnover ratios and understand a company's operational effectiveness.
Inventory accounting touches every part of production and operations. Missing parts can cause long delays, faulty safety equipment can bring lawsuits, and defective raw materials can stall output from the start.
Inventory accounting tracks everything needed to produce a sellable product from beginning to end. Companies should pay equal attention to all five inventory types. An adequately managed inventory keeps the supply chain running smoothly.
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