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This article is about business inventory. For other uses, see Inventory (disambiguation).
"Overstock" redirects here. For the online retailer, see Overstock.com. Overstockcom ( is an Online Retailer headquartered in Cottonwood Heights, Utah, near Salt Lake City.

Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business. Materials are physical Substances used as inputs to production or Manufacturing. A business (also called firm or an enterprise) is a legally recognized organizational entity designed to provide goods and/or services to Inventory are held in order to manage and hide from the customer the fact that manufacture/supply delay is longer than delivery delay, and also to ease the effect of imperfections in the manufacturing process that lower production efficiencies if production capacity stands idle for lack of materials.

Contents

Business inventory

The reasons for keeping stock

There are three basic reasons for keeping an inventory:

  1. Time - The time lags present in the supply chain, from supplier to user at every stage, requires that you maintain certain amount of inventory to use in this "lead time"
  2. Uncertainty - Inventories are maintained as buffers to meet uncertainties in demand, supply and movements of goods.
  3. Economies of scale - Ideal condition of "one unit at a time at a place where user needs it, when he needs it" principle tends to incur lots of costs in terms of logistics. So Bulk buying, movement and storing brings in economies of scale, thus inventory.

All these stock reasons can apply to any owner or product stage.

These classifications apply along the whole Supply chain not just within a facility or plant. A supply chain or logistics network is the system of organizations people technology activities information and resources involved in moving a product or service from

Where these stocks contain the same or similar items it is often the work practice to hold all these stocks mixed together before or after the sub-process to which they relate. This 'reduces' costs. Because they are mixed-up together there is no visual reminder to operators of the adjacent sub-processes or line management of the stock which is due to a particular cause and should be a particular individual's responsibility with inevitable consequences. Some plants have centralized stock holding across sub-processes which makes the situation even more acute.

Special terms used in dealing with inventory

Typology

1) Buffer/safety stock

2) Cycle stock (Used in batch processes, it is the available inventory excluding buffer stock)

3) De-coupling (Buffer stock that is held by both the supplier and the user)

4) Anticipation stock (builting up extra stock for periods of increased demand - eg icecreams for summer)

5) Pipeline stock (goods still in transit or in the process of distribution - have left the factory but not arrived at the customer yet)

Inventory examples

While accountants often discuss inventory in terms of goods for sale, organizations - manufacturers, service-providers and not-for-profits - also have inventories (fixtures, furniture, supplies, . An accountant is a practitioner of Accountancy, which is the measurement disclosure or provision of assurance about financial information that helps managers investors Manufacturing (from Latin manu factura, "making by hand" is the use of tools and labor to make things for use or sale A service provider is an Entity that provides services to other entities A non-profit organization ( abbreviated "NPO" also "not-for-profit" is a legally constituted Organization whose objective is to support or engage . . ) that they do not intend to sell. Manufacturers', distributors', and wholesalers' inventory tends to cluster in warehouses. Distribution (or place) is one of the four elements of Marketing mix. A warehouse is a commercial Building for Storage of Goods. Warehouses are used by Manufacturers Importers Exporters Retailers' inventory may exist in a warehouse or in a shop or store accessible to customers. A customer is someone who makes use of the paid products of an individual or Organization. Inventories not intended for sale to customers or to clients may be held in any premises an organization uses. Consumers refers to individuals or households that use goods and services generated within the economy. Stock ties up cash and if uncontrolled it will be impossible to know the actual level of stocks and therefore impossible to control them.

Whilst the reasons for holding stock are covered earlier, most manufacturing organizations usually divide their "goods for sale" inventory into:

For example:

Manufacturing

A canned food manufacturer's materials inventory includes the ingredients to form the foods to be canned, empty cans and their lids (or coils of steel or aluminum for constructing those components), labels, and anything else (solder, glue, . . . ) that will form part of a finished can. The firm's work in process includes those materials from the time of release to the work floor until they become complete and ready for sale to wholesale or retail customers. This may be vats of prepared food, filled cans not yet labelled or sub-assemblies of food components. It may also include finished cans that are not yet packaged into cartons or pallets. Its finished good inventory consists of all the filled and labelled cans of food in its warehouse that it has manufactured and wishes to sell to food distributors (wholesalers), to grocery stores (retailers), and even perhaps to consumers through arrangements like factory stores and outlet centers. An outlet store or factory outlet or "Best Saving Outlet" is a retail store in which Manufacturers sell their stock directly to the public

Logistics or distribution

The logistics chain includes the owners (wholesalers and retailers), manufacturers' agents, and transportation channels that an item passes through between initial manufacture and final purchase by a consumer. Logistics is the management of the flow of Goods, Information and other resources including Energy and people between the point of origin and the point Consumers refers to individuals or households that use goods and services generated within the economy. At each stage, goods belong (as assets) to the seller until the buyer accepts them. Distribution includes four components:

  1. Manufacturers' agents: Distributors who hold and transport a consignment of finished goods for manufacturers without ever owning it. Accountants refer to manufacturers' agents' inventory as "matériel" in order to differentiate it from goods for sale. Materiel (from the French "matériel" for equipment or hardware related to the word Material) is a term used in English to refer to the
  2. Transportation: The movement of goods between owners, or between locations of a given owner. Transport or transportation is the movement of people and goods from one place to another The seller owns goods in transit until the buyer accepts them. Sellers or buyers may transport goods but most transportation providers act as the agent of the owner of the goods.
  3. Wholesaling: Distributors who buy goods from manufacturers and other suppliers (farmers, fishermen, etc. Wholesaling is the sale of Goods or Merchandise to Retailers to industrial commercial institutional or other professional Business users ) for re-sale work in the wholesale industry. Wholesaling is the sale of Goods or Merchandise to Retailers to industrial commercial institutional or other professional Business users A wholesaler's inventory consists of all the products in its warehouse that it has purchased from manufacturers or other suppliers. A produce-wholesaler (or distributor) may buy from distributors in other parts of the world or from local farmers. Food distributors wish to sell their inventory to grocery stores, other distributors, or possibly to consumers.
  4. Retailing: A retailer's inventory of goods for sale consists of all the products on its shelves that it has purchased from manufacturers or wholesalers. The store attempts to sell its inventory (soup, bolts, sweaters, or other goods) to consumers.

High level inventory management

It seems that around about 1880[2] there was a change in manufacturing practice from companies with relatively homogeneous lines of products to vertically integrated companies with unprecedented diversity in processes and products. Those companies (especially in metalworking) attempted to achieve success through economies of scale - the gains of jointly producing two or more products in one facility. The managers now needed information on the effect of product mix decisions on overall profits and therefore needed accurate product cost information. A variety of attempts to achieve this were unsuccessful due to the huge overhead of the information processing of the time. However, the burgeoning need for financial reporting after 1900 created unavoidable pressure for financial accounting of stock and the management need to cost manage products became overshadowed. In particular it was the need for audited accounts that sealed the fate of managerial cost accounting. The dominance of financial reporting accounting over management accounting remains to this day with few exceptions and the financial reporting definitions of 'cost' have distorted effective management 'cost' accounting since that time. This is particularly true of inventory.

Hence high level financial inventory has these two basic formulas which relate to the accounting period:

  1. Cost of beginning inventory at the start of the period + inventory purchases within the period + cost of production within the period = cost of goods
  2. Cost of goods - cost of ending inventory at the end of the period = cost of goods sold

The benefit of these formulae is that the first absorbs all overheads of production and raw material costs in to a value of inventory for reporting. Purchasing refers to a business or organization attempting to acquire goods or services to accomplish the goals of the enterprise Cost of goods sold, COGS, or "cost of sales", includes the direct costs attributable to the production of the goods sold by a company The second formula then creates the new start point for the next period and gives a figure to be subtracted from sales price to determine some form of sales margin figure.

Manufacturing management is more interested in inventory turnover ratio or average days to sell inventory since it tells them something about relative inventory levels.

Inventory turn over ratio (also known as inventory turns) = cost of goods sold/Average Inventory=Cost of Goods Sold/((Beginning Inventory+Ending Inventory)/2)

and its inverse

Average Days to Sell Inventory=Number of Days a Year/Inventory Turn Over Ratio=365 days a year/Inventory Turn Over Ratio

This ratio estimates how many times the inventory turns over a year. This number tells us how much cash/goods are tied up waiting for the process and is a critical measure of process reliability and effectiveness. So a factory with two inventory turns has six months stock on hand which generally not a good figure (depending upon industry) whereas a factory that moves from six turns to twelve turns has probably improved effectiveness by 100%. This improvement will have some negative results in the financial reporting since the 'value' now stored in the factory as inventory is reduced.

Whilst the simplicity of these accounting measures of inventory are very useful they are in the end fraught with the danger of their own assumptions. There are in fact so many things which can vary hidden under this appearance of simplicity that a variety of 'adjusting' assumptions may be used. These include:

Business models including Just in Time (JIT) Inventory, Vendor Managed Inventory (VMI) and Customer Managed Inventory (CMI) attempt to minimize on-hand inventory and increase inventory turns. VMI and CMI have gained considerable attention due to the success of third party vendors who offer added expertise and knowledge that organizations may not possess.

Accounting perspectives

The basis of Inventory accounting

Inventory needs to be accounted where it is held across accounting period boundaries since generally expenses should be matched against the results of that expense within the same period. When processes were simple and short then inventories were small but with more complex processes then inventories became larger and significant valued items on the balance sheet[3]. This need to value unsold and incomplete goods has driven many new behaviours into management practise. Perhaps most significant of these are the complexities of fixed cost recovery, transfer pricing, and the separation of direct from indirect costs. This, supposedly, precluded "anticipating income" or "declaring dividends out of capital". It is one of the intangible benefits of Lean and the TPS that process times shorten and stock levels decline to the point where the importance of this activity is hugely reduced and therefore effort, especially managerial, to achieve it can be minimised. Lean manufacturing or lean production, which is often known simply as " Lean " is the practice of a theory of production that considers the expenditure

Accounting for Inventory

Each country has its own rules about accounting for inventory that fit with their financial reporting rules. Accountancy or accounting is the measurement statement or provision of assurance about financial information primarily used by Lenders managers,

So for example, organizations in the U. S. define inventory to suit their needs within US Generally Accepted Accounting Practices (GAAP), the rules defined by the Financial Accounting Standards Board (FASB) (and others) and enforced by the U.S. Securities and Exchange Commission (SEC) and other federal and state agencies. In the US, generally accepted accounting principles, commonly abbreviated as US GAAP or simply GAAP, are accounting rules used to prepare present The Financial Accounting Standards Board (FASB is a private Not-for-profit organization whose primary purpose is to develop generally accepted accounting principles The US Securities and Exchange Commission (commonly known as the SEC) is an independent agency of the United States government which holds primary responsibility Other countries often have similar arrangements but with their own GAAP and national agencies instead.

It is intentional that financial accounting uses standards that allow the public to compare firms' performance, cost accounting functions internally to an organization and potentially with much greater flexibility. Financial accountancy (or financial accounting) is the field of Accountancy concerned with the preparation of Financial statements for decision makers In Management accounting, cost accounting is that part of management accounting which establishes budget and actual cost of operations processes departments or product and A discussion of inventory from standard and Theory of Constraints-based (throughput) cost accounting perspective follows some examples and a discussion of inventory from a financial accounting perspective. Theory of Constraints (TOC is an overall Management philosophy. In Communication networks, such as Ethernet or Packet radio, throughput is the average rate of successful message delivery over a communication channel In Management accounting, cost accounting is that part of management accounting which establishes budget and actual cost of operations processes departments or product and Financial accountancy (or financial accounting) is the field of Accountancy concerned with the preparation of Financial statements for decision makers

The internal costing/valuation of inventory can be complex. Whereas in the past most enterprises ran simple one process factories, this is quite probably in the minority in the 21st century. Where 'one process' factories exist then there is a market for the goods created which establishes an independent market value for the good. Today with multi-stage process companies there is much inventory that would once have been finished goods which is now held as 'work-in-process' (WIP). This needs to be valued in the accounts but the valuation is a management decision since there is no market for the partially finished product. This somewhat arbitrary 'valuation' of WIP combined with the allocation of overheads to it has led to some unintended and undesirable results.

Financial accounting

An organization's inventory can appear a mixed blessing, since it counts as an asset on the balance sheet, but it also ties up money that could serve for other purposes and requires additional expense for its protection. In Business and Accounting, assets are everything owned by a person or company (all tangible and intangible property that can be converted into cash. In Financial accounting, a balance sheet or statement of financial position is a summary of a person's or organization's balances Inventory may also cause significant tax expenses, depending on particular countries' laws regarding depreciation of inventory, as in Thor Power Tool Company v. Commissioner. Thor Power Tool Company v Commissioner, 439 US 522 ( 1979) was a United States Supreme Court ruling which changed the way companies are allowed

Inventory appears as a [[current asset]] on an organization's balance sheet because the organization can, in principle, turn it into cash by selling it. Some organizations hold larger inventories than their operations require in order to inflate their apparent asset value and their perceived profitability.

In addition to the money tied up by acquiring inventory, inventory also brings associated costs for warehouse space, for utilities, and for insurance to cover staff to handle and protect it, fire and other disasters, obsolescence, shrinkage (theft and errors), and others. Insurance, in Law and Economics, is a form of Risk management primarily used to hedge against the Risk of a contingent loss Such holding costs can mount up: between a third and a half of its acquisition value per year. In business management holding cost is money spent to keep and maintain a stock of goods in storage

Businesses that stock too little inventory cannot take advantage of large orders from customers if they cannot deliver. The conflicting objectives of cost control and customer service often pit an organization's financial and operating managers against its sales and marketing departments. In popular usage "marketing" is the promotion of products especially Advertising and Branding However in professional usage the term has a wider meaning of Sales people, in particular, often receive sales commission payments, so unavailable goods may reduce their potential personal income. This conflict can be minimised by reducing production time to being near or less than customer expected delivery time. This effort, known as "Lean production" will significantly reduce working capital tied up in inventory and reduce manufacturing costs (See the Toyota Production System). Lean manufacturing or lean production, which is often known simply as " Lean " is the practice of a theory of production that considers the expenditure Working capital, also known as net working capital, is a financial metric which represents operating liquidity available to a business The Toyota Production System (TPS combines management philosophy and practices to form an integrated socio-technical system at Toyota.

The role of a cost accountant on the 21st-century in a manufacturing organization

By helping the organization to make better decisions, the accountants can help the public sector to change in a very positive way that delivers increased value for the taxpayer’s investment. It can also help to incentivise progress and to ensure that reforms are sustainable and effective in the long term, by ensuring that success is appropriately recognized in both the formal and informal reward systems of the organization.

To say that they have a key role to play is an understatement. Finance is connected to most, if not all, of the key business processes within the organization. It should be steering the stewardship and accountability systems that ensure that the organization is conducting its business in an appropriate, ethical manner. It is critical that these foundations are firmly laid. So often they are the litmus test by which public confidence in the institution is either won or lost.

Finance should also be providing the information, analysis and advice to enable the organizations’ service managers to operate effectively. This goes beyond the traditional preoccupation with budgets – how much have we spent so far, how much have we left to spend? It is about helping the organization to better understand its own performance. That means making the connections and understanding the relationships between given inputs – the resources brought to bear – and the outputs and outcomes that they achieve. It is also about understanding and actively managing risks within the organization and its activities.

FIFO vs. LIFO accounting

Main article: FIFO and LIFO accounting

When a dealer sells goods from inventory, the value of the inventory is reduced by the cost of goods sold (CoG sold). FIFO and LIFO accounting methods are means of managing inventory and financial matters involving the money a company ties up within inventory of produced goods raw materials parts components Cost of goods sold, COGS, or "cost of sales", includes the direct costs attributable to the production of the goods sold by a company This is simple where the CoG has not varied across those held in stock; but where it has, then an agreed method must be derived to evaluate it. For commodity items that one cannot track individually, accountants must choose a method that fits the nature of the sale. A commodity is anything for which there is demand but which is supplied without qualitative differentiation across a market Two popular methods exist: FIFO and LIFO accounting (first in - first out, last in - first out). FIFO and LIFO accounting methods are means of managing inventory and financial matters involving the money a company ties up within inventory of produced goods raw materials parts components FIFO regards the first unit that arrived in inventory as the first one sold. LIFO considers the last unit arriving in inventory as the first one sold. Which method an accountant selects can have a significant effect on net income and book value and, in turn, on taxation. In accounting, book value or carrying value is the value of an asset or according to its Balance sheet account balance Using LIFO accounting for inventory, a company generally reports lower net income and lower book value, due to the effects of inflation. This generally results in lower taxation. Due to LIFO's potential to skew inventory value, UK GAAP and IAS have effectively banned LIFO inventory accounting. The Generally Accepted Accounting Practice in the UK or UK GAAP, are the overall body of regulation establishing how company accounts must be prepared in the United Kingdom International Financial Reporting Standards (IFRS are standards and interpretations adopted by the International Accounting Standards Board (IASB

In computer science, FIFO and LIFO correspond to the queue and stack data structures, respectively. Computer science (or computing science) is the study and the Science of the theoretical foundations of Information and Computation and their A data structure in Computer science is a way of storing Data in a computer so that it can be used efficiently In fact, the acronyms are commonly used to denote the corresponding data structures.

Standard cost accounting

Standard cost accounting uses ratios called efficiencies that compare the labour and materials actually used to produce a good with those that the same goods would have required under "standard" conditions. A ratio is an expression which compares quantities relative to each other Economic efficiency is used to refer to a number of related concepts As long as similar actual and standard conditions obtain, few problems arise. Unfortunately, standard cost accounting methods developed about 100 years ago, when labor comprised the most important cost in manufactured goods. Standard methods continue to emphasize labor efficiency even though that resource now constitutes a (very) small part of cost in most cases.

Standard cost accounting can hurt managers, workers, and firms in several ways. For example, a policy decision to increase inventory can harm a manufacturing managers' performance evaluation. For article assessment process on Wikipedia see WikipediaVersion 1 Increasing inventory requires increased production, which means that processes must operate at higher rates. When (not if) something goes wrong, the process takes longer and uses more than the standard labor time. The manager appears responsible for the excess, even though s/he has no control over the production requirement or the problem.

In adverse economic times, firms use the same efficiencies to downsize, rightsize, or otherwise reduce their labor force. Workers laid off under those circumstances have even less control over excess inventory and cost efficiencies than their managers.

Many financial and cost accountants have agreed for many years on the desirability of replacing standard cost accounting. They have not, however, found a successor.

Theory of Constraints cost accounting

Eliyahu M. Goldratt developed the Theory of Constraints in part to address the cost-accounting problems in what he calls the "cost world". Eliyahu M Goldratt (1948 -) is an Israeli physicist turned business consultant Theory of Constraints (TOC is an overall Management philosophy. He offers a substitute, called throughput accounting, that uses throughput (money for goods sold to customers) in place of output (goods produced that may sell or may boost inventory) and considers labor as a fixed rather than as a variable cost. Throughput Accounting (TA is an alternative to Cost accounting proposed by Eliyahu M In the business management Theory of Constraints, throughput is the rate at which a System achieves its goal He defines inventory simply as everything the organization owns that it plans to sell, including buildings, machinery, and many other things in addition to the categories listed here. Throughput accounting recognizes only one class of variable costs: the operating expenses like materials and components that vary directly with the quantity produced. An operating expense, operating expenditure, operational expense, operational expenditure or OPEX is an on-going cost for running a product

Finished goods inventories remain balance-sheet assets, but labor efficiency ratios no longer evaluate managers and workers. In Financial accounting, a balance sheet or statement of financial position is a summary of a person's or organization's balances Instead of an incentive to reduce labor cost, throughput accounting focuses attention on the relationships between throughput (revenue or income) on one hand and controllable operating expenses and changes in inventory on the other. Those relationships direct attention to the constraints or bottlenecks that prevent the system from producing more throughput, rather than to people - who have little or no control over their situations. Project management In Project Management a Bottleneck is one process in a chain of processes such that its limited capacity reduces the capacity of the whole chain

National accounts

Inventories also play an important role in national accounts and the analysis of the business cycle. National accounts or national account systems (NAS provide a complete and consistent conceptual framework for measuring the economic activity of a nation (or other geographic The term business cycle or economic cycle refers to the fluctuations of economic activity during its long term growth trend Some short-term macroeconomic fluctuations are attributed to the inventory cycle. Macroeconomics is a branch of Economics that deals with the performance structure and behavior of a national or regional Economy as a whole

Distressed inventory

Also known as distressed or expired stock, distressed inventory is inventory whose potential to be sold at a normal cost has or will soon pass. In certain industries it could also mean that the stock is or will soon be impossible to sell. Examples of distressed inventory include products that have reached its expiry date, or has reached a date in advance of expiry at which the planned market will no longer purchase it (e. g. 3 months left to expiry), clothing that is defective or out of fashion, and old newspapers or magazines. Fashion refers to styles of dress (but can also include cuisine literature art architecture and general comportment that are popular in a culture at any given time It also includes computer or consumer-electronic equipment that is obsolescent or discontinued and whose manufacturer is unable to support it.

See also

References

  1. ^ Financial dictionary, formerly at http://www.specialinvestor.com/terms/1072.html, Special Investor
  2. ^ Relevance Lost, Johnson and Kaplan, Harvard Business School Press, 1987, p126
  3. ^ Relevance Lost: The rise and fall of management accounting, p130, Johnson, H T, Kaplan, R S, Harvard Business School Press, 1987, ISBN 0-87584-138-4

Further reading

Dictionary

inventory

-noun

  1. the stock of an item on hand at a particular location or business
  2. a detailed list of all of the items on hand
  3. the process of producing or updating such a list

-verb

  1. (transitive) To take stock of the resources or items on hand; to produce an inventory.
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