03 July, 2020

Inventory Basics: What Is Inventory Management?

Welcome to Inventory Management Basics. Here, we’ll be looking at exactly what inventory and inventory management are and why they’re so important.

We’ll also provide basic definitions of the different types of inventory.

What is inventory?

The most basic definition of inventory is the materials or “things” your business owns. These can be tangible (products and raw materials) or intangible (e.g., software). In most cases, when we refer to inventory, we simply mean all the materials the business has kept in stock—to sell. But, in some cases, it can be inventory that’s not intended for sale, such as fixtures and fittings. These kind of items are generally counted for financial and/or insurance purposes and are known as maintenance, repair, and operating supplies, or MRO goods (definition below).

Inventory can be listed as either an asset or a liability. If a business has lots of inventory, it can convert that inventory into revenue by selling it. Conversely, having too much Inventory can also end up costing the business if that inventory doesn’t get sold.

What are the 4 basic types of inventory?

Inventory can be classified into four main types:

  • Raw materials are ingredients or components used to manufacture a finished product. A brewer, for example, will use grain, yeast and hops as ingredients in the fermentation process to produce a volume of beer.
  • Work in progress (WIP) represents inventory in production and not yet ready for sale, for example, beer still in the process of fermenting.
  • Finished goods are products in your inventory that are ready to be sold to your customers. This inventory type is common to all companies that sell products.
  • Maintenance, repair and operating supplies (MRO goods) are used to support production processes and infrastructure. Such goods are usually consumed during production but are not part of the finished product. Examples include lubricants, coolants, janitorial supplies, uniforms, gloves, packing materials, tools and office supplies, including computers.

Are there other types of inventory?

Yes. Inventory can be further classified by the purpose it serves.

  • Buffer inventory, or buffer stock, is the amount of stock you hold as a precaution against stock-outs and is also sometimes called safety stock. Buffer stock has two benefits, nonstop production and increased customer satisfaction. While these benefits come with increased carrying costs, being able to deliver finished goods at a moment’s notice may be worth it.
  • Transit inventory refers to raw materials, WIP, finished goods and MRO being moved from from location to other for any purpose. Long distances can mean that inventory is in transit for anywhere from days to months. Also known as goods in transit.
  • Anticipation inventory or anticipatory stock is raw materials or finished goods kept in anticipation of demand based on past or seasonal trends or current events that are expected to drive price hikes. Traders are most likely to use this strategy.
  • Decoupling inventory is an inventory of parts between machines (i.e., one machine feeds parts to the next machine), allowing sequential, dependent processes that typically run at different speeds to stay in sync, as machinery is generally always running, other than when it’s being serviced. Decoupling inventory serves to regulate production flow.
  • Cycle inventory is inventory a seller cycles through to fulfill regular sales orders and results from ordering in batches or lot sizes to optimize carrying costs versus machinery setup costs, rather than ordering material only as needed. Part of on-hand inventory, or stock on hand, which includes all items the seller has in its possession, cycle stock equals total stock on hand minus safety stock.

What is inventory management?

When we refer to inventory management, we mean the theories, processes and tools involved in controlling inventory at each stage, from sourcing to storing to selling. The core purpose of inventory management is to make sure that you have the right amount of stock on hand at the right time—at the right cost and price. What is an inventory management system? An inventory management system describes the processes and tools used, physical and/or digital, to track, record and analyze inventory movements and sales performance across the supply chain. Cin7 is an example of a cloud-based inventory management system that uses an integrated software platform to efficiently perform all of these tasks.

Why is inventory management important?

Because to run a successful product-focused business, you need to have enough inventory to sell, to satisfy customers and meet market demand. Systematic and transparent inventory management is therefore critical to a business’s bottom line. For instance, it costs money to store inventory, so inventory managers or other stakeholders try to determine the minimum amount of space required to store the maximum amount of inventory.

There are many metrics used to determine whether or not the business is doing a good job of managing inventory. One of these metrics is inventory turnover ratio. Generally, the higher the ratio, the better it is for the company, because it means that inventory isn’t sitting idle on warehouse shelves, where it doesn’t make money and in fact costs money. Rather, it is being used in production or sold in stores.

For more information, including basic inventory formulas, metrics and accounting methods, see our resources page What is inventory management?

From a product perspective, inventory management’s importance lies in understanding what stock you have on hand, where it is in your warehouse(s), and how it’s coming in and out of your supply chain.

Clear, real-time inventory visibility helps you:

  • Reduce costs
  • Optimize fulfillment
  • Excel at customer service
  • Minimize loss due to theft, spoilage and/or returns

From an organizational perspective, inventory management provides insights into your financial standing, customer behavior, sales trends, product development and potential business opportunities.

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