Also referred to as stock in British English, inventory represents the products, raw materials and other consumable that are in the possession of the company (or that is owns). As referred in the raw materials and consumables page, these are the goods that are used in the production process or service delivery and will become integrated in the product or service.
If your business involves a transformation process, inventory includes:
- Raw materials and consumables: items that will be integrated into a new product or service.
- Subassemblies or intermediated products: items that have gone through some sort of transformation but do not yet correspond to the finished product.
- Finished products: products that are finished and ready to be sold.
If your business involves the sale (either wholesale or retail) of products without a transformation process, the inventory includes:
- Products: products that have been bought to be resold.
Inventory management is a relevant part of the business, especially when manufacturing is included and aspects such as shrinkage, inventory valuation and running procedures are to be addressed.
Inventory running procedures include (among other):
- Ordering goods.
- Storage of the inventory.
- Controlling the number of products in stock that are ready to be sold (finished goods).
Inventory management is quite important for a continuous feeding of the production process; a company cannot afford to run out, even if temporarily, of the raw materials and consumables needed to manufacture the products or services it sells, as that will most likely affect its capacity to deliver the goods to its clients, unless it holds enough finished goods in stock. On the opposite side, the company must also balance out the number of goods it holds in stock, independently of these being raw materials and consumables, intermediate goods or finished products. Holding an excess of inventory means:
- More cash invested in inventory.
- Higher risk of becoming obsolete (meaning that raw materials and consumables may become unfit for the production process or that finished goods may lose value of sale).
- Higher costs in warehousing.
- More complex management systems.
- More risk of shrinkage.
Determining the perfect level of inventory for a company depends on its business type, warehouse and production facilities among other features. A common concept is that of days of inventory, which compares the inventory to the consumption of raw materials and consumables at a given period.
Over the years several supply chain management systems have emerged, such as:
- Re-order quantity point.
- Material requirement program.
- Kanban inventory.
A company needs to also ensure that the acquired raw materials and consumables have the correct qualities and features, so that the finished product or service has the exact quality and features that the company states. The control of the acquisition cost of each raw material or consumable involved in the process of your product or service is also relevant, as a loose control of this aspect and it can bring the gross margin to levels that make your business unsustainable.
Shrinkage corresponds to the reduction of the number of items of a certain good that a company holds in stock. Due to the shrinkage effect, companies experience losses in their inventories which will have to be recognized as costs (but not costs of production). Shrinkage is the result of:
- Damaging of the good.
- External theft (or theft outsiders of the company).
- Internal theft (or theft by insiders).
- Obsolescence or perishability of the goods.
- Administrative or paperwork errors and warehouse discrepancies.
- Other causes.
Over the years, shrinkage has been the subject of several studies and it is a known issue in several industries, particularly in the retail sector, an industry where most companies admit that the shrinkage is a problem that affects profitability.