What is inventory?
Inventory is a set of goods in existence destined to carry out an operation, be it purchase, rental, sale, use, or transformation and in this way ensure the service to internal and external customers. It must appear, accounting, within the asset as a current asset.
At the end of reading you will be able to define what an inventory is, you will understand how it affects the financial objectives of a company, you will recognize its different types, you will understand its usefulness, in addition to knowing its accounting systems and its valuation methods. This information is complemented by a video course that presents essential concepts of accounting management of a company’s inventories.
A company’s inventories are made up of its raw materials, its products in process, the supplies it uses in its operations, and finished products. An inventory can be something as basic as a bottle of glass cleaner used as part of a building’s maintenance program, or something more complex, such as a combination of raw materials and subassemblies that are part of a manufacturing process. (Müller, p.1)
Set of corporeal, tangible, and in-stock goods, owned and immediately available for consumption (raw material), transformation (products in the process), and sale (goods and finished products). (Perdomo, p.72)
Inventory is defined as the accumulation of materials (raw materials, work-in-progress, finished goods, or items in maintenance) that will later be used to meet future demand. (Moya, p.19)
The stock is the set of products stored awaiting their subsequent use, more or less close, which allows regular supply to those who consume them, without imposing on them the discontinuities that manufacturing entails or possible delays in deliveries by suppliers. (Ferrin, p.47)
Inventories are defined as idle goods stored waiting to be used. (Eppan, p.364)
The financial impact of inventory
The constitution of inventories involves two types of factors: Positive, since it provides the company with operational flexibility, allowing it to produce at a different rate than the acquisition rate and offering the possibility of issuing larger volume orders; and Negative since a series of financial and management costs appear that are harmful to the economy of the organization. (Cruelles, p.78)
When performing financial analysis, the impact of inventory on three of the basic financial ratios is observed :
- It affects Net Profit by contributing expenses ( inventory costs ) such as leasing or purchasing warehouses, depreciation, materials management systems, and labor costs associated with their maintenance, conservation, and administration, among others.
- In cash flow, it impacts the well-known acid test [(Current Assets – Inventories) ÷ Current Liabilities], which shows the firm’s ability to meet its short-term obligations. A high inventory will show less ability of the company to respond on this front.
- The Return on Investment (ROI) [Net Profit ÷ Total Assets], impacts both Net Profit, through expenses as already explained, and Total Assets (Fixed Assets + Current Assets) since it makes up current assets along with bank accounts and accounts receivable.
Types of Inventories
There are different classifications, some of them are listed below.
According to its shape
- Raw Materials Inventory: It is made up of all the materials with which the products are made, but which have not yet received processing.
- Inventory of Products in Manufacturing Process: It is made up of all those goods acquired by manufacturing or industrial companies, which are in the manufacturing process. Its quantification is done by the amount of materials, labor, and manufacturing expenses, applicable to the closing date.
- Inventory of Finished Products: These are all those goods acquired by manufacturing or industrial companies, which are transformed to be sold as finished products.
There is a type of complementary inventory, depending on its form, that is not commonly cited in the literature:
- Factory Supplies Inventory: These are the materials with which the products are made, but which cannot be accurately quantified (Paint, sandpaper, nails, lubricants, etc.).
Additionally, in commercial companies, there are:
- Merchandise Inventory: It is made up of all those assets that belong to the company, whether commercial or commercial, which are bought and then sold without being modified. This Account will show all the merchandise available for Sale. Those that have other characteristics and are subject to particular conditions must be shown in separate accounts, such as merchandise on the way (those that have been purchased and not yet received), merchandise given on consignment, or pledged merchandise (those that are owned by of the company but that have been given to third parties in the guarantee of value that has already been received in cash or other goods).
According to its function
According to Castillo (p.5):
- Safety or reserve inventory is that which is maintained to offset the risks of unplanned stoppages of production or unexpected increases in customer demand.
- Decoupling inventory is the one that is required between two adjacent processes or operations whose production rates cannot be synchronized; this allows each process to work as planned.
- Inventory in transit is made up of materials that advance in the value chain. These materials are items that have been ordered but not yet received.
- Cycle inventory results when the number of units purchased (or produced) to reduce costs per unit purchase (or increase production efficiency) is greater than the immediate needs of the company.
- Forecast or seasonal inventory accumulates when a company produces more than immediate requirements during periods of low demand to meet those of high demand. Frequently, this accumulates when the demand is seasonal.
From the logistics point of view
For Ballou (p.330, 331) they can be classified as follows:
- In pipelines: these are the inventories in transit between the levels of the supply channel. Work-in-process inventories in manufacturing operations can be considered pipeline inventory.
- Speculative Stocks – Commodities such as copper, gold, and silver are purchased both to speculate on price and to meet operating requirements and when inventories are established in advance of seasonal or seasonal sales.
- Inventories of a regular or cyclical nature: These are the inventories necessary to satisfy the average demand during the time between successive replenishments.
- Safety Stock – The inventory that can be built to protect against variability in stock demand and total replenishment time.
- Obsolete, Dead, or Lost Stock – When held for a long time, it deteriorates, expires, is lost, or is stolen.
