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Main Dictionary I


Inventory is materials for manufacturing and produced goods available for sale. In a balance sheet of a company it is considered as a current asset, earning income and profit for the company's shareholders.

Understanding Inventory

Inventory is a buffer between production and order completion. Inventory carrying value is taken to the COGS (cost of goods sold) category on the income statement, when inventory is sold. Inventory can be valued by 3 ways:

  • FIFO (first-in, first-out). The cost of previously purchased materials defines the cost of goods sold. The cost of the materials purchased most recently defines the balance sheet value of the remaining inventory.
  • LIFO (last-in, first-out). The cost of most recently purchased materials defines the cost of goods sold. The cost of previously purchased materials defines the cost of remaining inventory.
  • Weighted average. Inventory valuation is made on the base of the average cost of all the materials purchased over a time period and called as the cost of goods sold.

Important note: Inventory turnover can tell if a company has too little or too much inventory. To find out the number of company sales of products over a period of time, you can look at a company's inventory turnover rate. Company managers, analysts, and investors have access to this information.

Types of Inventory

The IRS classifies supplies and goods as additional categories of an inventory. Inventory is divided into 3 types: finished products, work-in-process, and raw materials.

Raw materials are what is used to make a product, unprocessed materials (aluminum and steel for making cars; flour for bakeries that make bread; crude oil stored in refineries). Work-in-process inventories (inventories on the production facility) are semi-finished products from which a finished product will be obtained for resale. A half-assembled airliner or some completed car units are often considered as work-in-process inventory.

Finished products are things that have passed the manufacturing process, completed products that are ready for sale. Such inventories in the retail trade are merchandise (electronics, clothing, and automobiles in retailers' storage).

Inventory Management

A large amount of inventory over a long-term is costly (storage, spoilage, risk of obsolescence) for a business.

A small amount of inventory brings the risk of losing part of the market and losing profits from potential sales.

Companies need inventory management strategies and forecasts to minimize inventory costs (goods are created or arrive only on demand). One of these strategies is the JIT (just-in-time) inventory system, which calculates cost of goods with backwash.

Special Considerations

Consignment inventory is the inventory of a wholesaler, supplier, or manufacturer that is kept by a retailer (buyer). Many manufacturers deal with retailers to consign their inventory. The retailer pays for the stock after it is sold to the end consumer or after it is used (e.g., to make his or her own products).

The supplier benefits from having product promotion by the customer and easily available to the end consumer. The customers benefit from not spending capital until the product is beneficial for them. They purchase it only when the end consumer buys it from them or until they have used up inventory for their business.

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