Inventory is the collection of goods or materials held by a business for eventual sale. Also known as stock, inventory can include finished products ready for sale or the materials used to manufacture the finished products.
Inventory tracking and management is a crucial area of oversight for any business. Because it often includes both finished products and pipeline materials, inventory processes are vital to a business’s bottom line.
The five types of inventory are:
To more effectively manage and store goods, it’s essential to understand the differences between these types of stock or inventory.
Raw materials inventory is what it sounds like – the primary materials used to make finished goods. Suppliers may either purchase this type of stock from another company or produce it directly.
For example, a furniture-making company might have a stock of raw wood bought from a supplier. The wood is their raw materials inventory.
There are two types of raw materials inventory: direct and indirect.
Direct raw materials make up the parts of the final product. The wood in the example above is a direct raw material.
Indirect raw materials are materials that don’t appear in the finished product but are consumed during production. In the example above, with furniture making, any disposable tools, cleaning products, fuel, etc., would be considered indirect raw materials.
Work-in-progress or work-in-process goods are the finished products before completion. These goods are any product that’s partially through development. WIP also includes everything that is in use during production. So raw materials are part of the raw materials inventory while they’re sitting on a shelf waiting for use, but they become part of the WIP inventory when they’re in use.
In the furniture example, WIP inventory is anything used during the actual making of the furniture. WIP inventory is counted as an asset and has its accounting entry in a company’s general ledger.
Once the piece of furniture is complete, it moves out of WIP inventory and into finished goods inventory, which we’ll explain next.
The manufacturer has built a piece of furniture and made it ready for the showroom floor! It’s not officially part of the finished goods inventory. Finished goods inventory can come from the raw materials and work-in-progress supply chain, 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 once ready.
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 a 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. And yet, MRO is critical to track and manage. Imagine if the furniture maker had a faulty piece of machinery that sidelined a whole part of the manufacturing line. If the manufacturer doesn’t have a replacement part on hand, productivity loss over time could be considerable.
Companies need to regularly replenish MRO inventory to keep a business operating at total capacity. Here are a few best practices to stay on top of it.
Identify critical processes: Suppliers should understand which processes are most critical to business function and how quickly they use their resources. Businesses should ensure they have a plan to keep these essential pieces of stock.
Increase efficiency: Larger businesses need to audit their operations and processes and ensure they don’t have overlap. They should 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 lower. Document a forecast of these high and low seasons.
Use an inventory management system: Multiple different teams may need the same MRO materials. Companies don’t want everyone buying the same thing from other suppliers or at additional costs, all paying for shipping, etc. Centralizing inventory management helps avoid these issues.
Packing materials inventory is the easiest one to understand. This type of stock includes any products or items used to pack a business’s products, like boxes, bubble wrap, and shipping materials. Packing materials can also include things like casings, toothpaste tubes, etc.
As with MRO, packing materials inventory can be an easy place to experience waste. Companies need to ensure they have a sound inventory management system in place and centralized ordering and tracking.
One can categorize all five main types of inventory as safety stock or cycle stock inventory. Cycle stock is all 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.
Businesses can store their inventory in any of the following locations:
These storage locations can be within the business itself, or the company can outsource to a third-party logistics company (3PL).
While it may not seem like the most glamorous part of business, inventory management is critical to successful operations and increasing profit margins.
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: raw materials inventory, work-in-progress (WIP) inventory, maintenance, repair, and operating (MRO) inventory, finished goods inventory, and packing materials inventory.
An adequately managed inventory keeps a business humming along smoothly.
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