What Do You Mean By Inventory?
Inventory means in Accounts all the goods, items, materials, and merchandise that are held by a business so that it can sell them in the market and make a profit from them. The term inventory also refers to one of the major important factors of the business called the asset because they are the major turnover of the inventory. Inventory is also the primary source of the subsequent earnings and revenue generation that are available for the stakeholders of the company. Inventory refers to the finished goods that are held by any company.
Inventory And Its Types
Inventory is mainly categorized as work-in-progress, raw materials, and finished goods.
Raw materials refer to the various unprocessed materials that are used to make goods. Some of the examples of raw materials are steel and aluminium used for making cars, flour which is required for the production of bread in a bakery, and oil that are held by various refineries.
Work-in-progress inventory refers to the goods that are finished partially and have been kept for resale and completion. The term is also known as the inventory present on any work floor. Examples include a yacht that is partially completed or an airliner that is half-assembled.
It also refers to finished products that are the products already completed and are ready for marketing. They are ready for selling purposes and can be used by the consumers who purchase them. This inventory is also known as merchandise. Examples of such inventory include cars, furnished products, clothes, and electronics.
Inventory in Economics
Inventory plays an important and efficient role in the trading and manufacturing business and so the businessman needs to understand the importance of economics in the growth of an inventory. The inventory should be processed well to produce more products that result in the positive growth of the company.
Indirect Inventory
It refers to the stock items necessary for the production of goods but they are not the direct component of those goods or products. Such goods can be ancillary goods that refer to the situation where the company cannot link them with final units of the finished goods. These indirect inventories form the distribution, selling as well as administrative purpose. The examples include oils and petrol that are used in indirect inventories. Office supplies also fall under indirect inventories.
Live Inventory Meaning
Live inventory helps an individual to easily handle all the multiple channels by checking that they are up-to-date as well as accurate. This also refers to the selling process by increasing sales, stopping oversell, and giving confidence.
Inventory Means in Account
Inventory accounting refers to the accounting that deals with the accounting and valuation changes that can be introduced in the inventoried assets. The inventory of a company generally deals with goods that involve three stages of production. Inventory accounting assigns values to all the items in the three stages and prepares them for sale.
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FAQs on Inventory Classification and Importance
1. What is inventory in the context of business studies and accounting?
Inventory, also known as stock, refers to the goods and materials a business holds for the ultimate purpose of resale or repair. As per accounting principles, it is classified as a current asset on a company's balance sheet. It generally includes three main types: raw materials, work-in-progress, and finished goods.
2. Why is the classification of inventory considered important for a business?
Proper inventory classification is crucial for effective management and financial health. Its importance lies in:
Optimising Investment: It prevents the locking up of capital in unnecessary or slow-moving stock.
Cost Reduction: It helps minimise holding costs, such as storage, insurance, and obsolescence.
Operational Efficiency: It ensures that essential items are always available, preventing production halts or lost sales due to stockouts.
Better Control: It allows managers to apply different levels of control based on the value and importance of items.
3. What are the main types of inventory held by a manufacturing company?
A manufacturing business typically holds three primary classifications of inventory:
Raw Materials: These are the basic inputs that are converted into a final product. For example, wood for a furniture maker.
Work-in-Progress (WIP): These are partially finished goods at various stages of the production process. For example, a chair that has been assembled but not yet polished.
Finished Goods: These are the completed products ready for sale to customers. For example, a fully polished and packaged chair.
4. What are the most common methods used for classifying inventory?
Businesses use several analytical methods to classify inventory for better control. The most common techniques include:
ABC (Always Better Control) Analysis: Classifies items based on their annual consumption value.
VED (Vital, Essential, Desirable) Analysis: Classifies items based on their operational criticality.
FSN (Fast-Moving, Slow-Moving, Non-Moving) Analysis: Classifies items based on their rate of consumption or turnover.
5. How does ABC analysis help a business prioritise its inventory management efforts?
ABC analysis applies the Pareto principle (80/20 rule) to inventory. It categorises items to focus management attention effectively:
Category A: High-value items that constitute 70-80% of total consumption value but only 10-20% of total items. These require strict control and frequent review.
Category B: Medium-value items, representing about 15-25% of value and 20-30% of items. These require moderate control.
Category C: Low-value items that make up only 5% of value but 50-60% of total items. These require simple, low-cost control methods. By doing this, a company ensures its most valuable assets are managed most carefully.
6. What is the key difference between ABC analysis and VED analysis of inventory?
The primary difference lies in the basis of classification. ABC analysis classifies inventory based on its monetary value (consumption value), helping to control the financial investment in stock. In contrast, VED analysis classifies inventory based on its criticality or importance to the production process (Vital, Essential, Desirable). A low-cost item could be 'Vital' if its absence halts production, while an expensive item could be 'Desirable' but not critical. Businesses often use both methods together for robust control.
7. Can you provide a real-world example of inventory classification in a retail store?
Consider a supermarket. Using ABC analysis, high-value items like premium electronics or imported goods would be 'Category A' items, tracked daily. Dairy and fresh produce would also be high-priority due to spoilage. Using FSN analysis, milk and bread would be 'Fast-Moving', requiring frequent restocking. Spices or specialty canned goods might be 'Slow-Moving', while a discontinued brand of sauce would be 'Non-Moving' and targeted for clearance.
8. What are the potential risks for a company that fails to classify its inventory properly?
Failing to classify inventory can lead to significant business risks. These include:
Capital Lock-up: Overstocking slow-moving or obsolete items ties up working capital that could be used elsewhere.
Lost Sales: Understocking fast-moving or critical items can lead to stockouts, resulting in lost revenue and dissatisfied customers.
Increased Costs: Poor classification can lead to higher carrying costs, including storage, insurance, and losses due to spoilage or damage.
Inaccurate Financials: Incorrect inventory valuation can distort the company's balance sheet and profit and loss statements, affecting investor confidence and tax liabilities.
