Inventory, Types of Inventory, and Inventory Valuation


What is Inventory?

The term inventory refers to both the raw materials used in production and the finished goods that are available for sale. Inventory is one of a company’s most valuable assets because inventory turnover is one of the primary sources of revenue generation and subsequent earnings for the company’s shareholders. Raw materials, work-in-progress, and finished goods are the three types of inventory. On a company’s balance sheet, it is classified as a current asset.

Inventory Valuation (Inventory Accounting)

How inventory is valued?

Inventory is valued at Lower of;

  • Cost; and
  • Net Realizable Value (NRV)

Methods of Inventory Valuation

Inventory can be valued in three different ways. These are the methods:

  • First-in, first-out (FIFO)
  • Last-in, first-out (LIFO)
  • Weighted average

First-in, first-out (FIFO)

First-in, first-out (FIFO) method states that the cost of goods sold is determined by the cost of the first purchased materials. The carrying cost of remaining inventory, on the other hand, is determined by the price of the most recently purchased materials.

Last-in, first-out (LIFO)

Last-in, first-out (LIFO) method states that the cost of goods sold is calculated using the cost of the most recently purchased materials, while the value of remaining inventory is calculated using the most recently purchased materials.

Weighted Average

Weighted average method entails valuing both inventory and COGS based on the average cost of all materials purchased during the period.

Types of Inventory

Remember that inventory is typically divided into three categories:

  • Raw Materials,
  • Work-in-Process, and
  • Finished Goods.

The IRS classifies merchandise and supplies as additional inventory categories.

Raw materials

Raw materials are unprocessed materials that are used to make a product. Raw materials include, for example:

  • Aluminum and steel are used in the production of automobiles.
  • Bread flour held by bakeries
  • Crude oil held by refineries


Work-in-progress inventory refers to partially finished goods that are awaiting completion and resale. WIP inventory is also referred to as production floor inventory. Work-in-process inventory can include a partially assembled airliner or a partially finished yacht.

Finished goods

Finished goods are products that have completed the manufacturing process and are ready for sale. This inventory is commonly referred to as merchandise by retailers. Electronics, clothing, and automobiles are common examples of merchandise held by retailers.

A periodic system is best suited to small businesses with easy-to-account-for stock because no continuous records are kept and businesses must guess the cost of goods sold during interims. Larger businesses are more likely to encounter serious inaccuracies in stock estimation, increasing the risk of overstocking, understocking, and failing to identify trends.

Inventory Management

Having a large amount of inventory for an extended period of time is usually not a good idea for a business. This is due to the challenges it presents, such as storage costs, spoilage costs, and the threat of obsolescence.

Having too little inventory has its drawbacks as well. For example, a company may risk losing market share and profit from potential sales.

Inventory management forecasts and strategies, such as a just-in-time (JIT) inventory system (with backflush costing), can help businesses reduce inventory costs by creating or receiving goods only when they are needed.

Inventory management assists businesses in determining which and how much stock to order at what time. It keeps track of inventory from purchase to sale. The practice identifies and responds to trends to ensure that there is always enough stock to fulfill customer orders and that a shortage is properly announced.

Inventory becomes revenue once it is sold. Inventory (despite being reported as an asset on the balance sheet) ties up cash before it is sold. As a result, having too much stock costs money and reduces cash flow.

Inventory turnover is one indicator of good inventory management. Inventory turnover is an accounting metric that reflects how frequently stock is sold in a given period. A company does not want more inventory than sales. Inadequate inventory turnover can result in deadstock, or unsold stock.

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Inventory Management System

What Is an Inventory Management System?

An inventory management system integrates various software packages to track stock levels and movements. The solution is compatible with multichannel sales and shipping systems.

Inventory management systems optimize inventory levels while also ensuring product availability across multiple channels. It offers a centralized, real-time view of all items, inventory, and orders across all locations and selling channels. This allows businesses to stock less inventory and frees up cash for use in other areas of the business. An inventory management system assists in lowering inventory costs while meeting customer expectations.

How to Choose an Inventory Management System?

Choosing an inventory management system is a matter of determining which features your company requires.

With so many inventory management systems on the market, determining which one is best for your company can be difficult.

Here are the most critical factors to consider when selecting an inventory management system.

  • What challenges does your company face when it comes to inventory management?
  • Do you frequently overstock or do you not have enough stock?
  • Are you able to divide stock into safety stock, replenishment stock, and normal stock in an efficient and accurate manner?
  • Do you have a problem with visibility across multiple warehouse locations?
  • Are you having difficulty effectively costing to accommodate fluctuations in customer demand?
  • What systems do you want the inventory management system to work with?
  • Who is going to use your inventory management system?

Good inventory management software should:

  • Reduce costs, improve cash flow, and increase your company’s bottom line.
  • Maintain real-time inventory tracking.
  • Assist you in forecasting demand
  • Prevent product and manufacturing shortages.
  • Avoid having too much inventory and raw materials.
  • Allow for simple inventory management on any device.
  • Be accessible from your retail point of sale.
  • Optimize warehouse organization and valuable employee time by providing quick and painless bar code scanning to expedite intake.
  • Allow for multilocation management, such as inventory tracking across multiple locations or warehouses.

Examples of Inventory Management System

Periodic Inventory System

The periodic inventory method is a method of inventory valuation in which stock is physically counted at the end of each accounting period rather than continuously. This data is used to update the general ledger’s ending inventory balance, which is then applied to the beginning inventory.

Perpetual Inventory System

For an accurate and detailed view of inventory information, the perpetual inventory management method involves continuously recording stock intake and product sales in real-time. Businesses can avoid stockouts by keeping inventory levels optimal because inventory records are automatically updated immediately after each transaction of goods received or sold.

Cloud Inventory Management Software

What is Cloud Inventory Management Software?

Cloud inventory management software improves inventory control significantly. It enables you to access, monitor, and manage your inventory data from anywhere in the world using any internet-connected device.

Inventory control systems are hosted in remote data centers by Software as a Service (SaaS) providers, removing the significant costs associated with hardware and overhead management while providing businesses with extra security and increased redundancy. They also handle installation, maintenance, upgrades, and patches, so businesses don’t have to waste time on these back-end tasks.

While some businesses prefer full ownership of legacy systems, cloud-based solutions have exploded in popularity as the business environment demands agility and adaptability. In fact, the inherent flexibility of cloud-based solutions is its most appealing and powerful advantage.

Because the service is hosted in the cloud, you are no longer required to be present in the warehouse, store, or office to monitor and manage inventory records.

Employees have complete access to their inventory at all times and from any location. You and your employees can quickly sign into your provider’s app on your mobile phone or desktop and perform inventory management tasks with the same (if not greater) efficiency and visibility as you would with a traditional inventory management system.

Inventory Control

Inventory control, also known as stock control, is the process of managing a company’s inventory levels, whether in its own warehouse or in multiple locations. It entails managing items from the time they are in stock to their final destination (ideally, customers) or disposal (not ideal).

How can we control inventory?

Here are some of the techniques that many small businesses use to manage inventory:

  1. Fine-tune your forecasting
  2. Use the FIFO approach (first in, first out)
  3. Identify low-turn stock
  4. Audit your stock
  5. Use cloud-based inventory management software
  6. Track your stock levels at all times
  7. Reduce equipment / machinery repair times
  8. Don’t forget quality control – Whatever your specialty, it’s critical that all of your products look great and function properly.
  9. Hire a stock controller
  10. Remember your ABCs – Split inventories into categories A, B, and C.
  11. Consider drop shipping – You can sell products without actually holding inventory if your company uses drop shipping methods.

What Can Inventory Tell You About a Business?

The rate of inventory turnover is one way of evaluating / assessing company’s performance. When a company sells inventory more quickly than its competitors, it incurs lower holding costs and lower opportunity costs. As a result, they frequently outperform, as this improves the efficiency of its product sales.

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