Chapter #1

What is Inventory: Definitions, Examples, Types, Valuation, and More

In this chapter, we will explain the basics of inventory from what inventory is, the different inventory definitions based on industries, the inventory valuation, and types of inventory, provide many different examples of inventory, to the difference between inventory and asset, and way more to improve your inventory management.

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What is Inventory: Definitions, Examples, Types, Valuation, and More

In our day-to-day life, we encounter so many different types of inventories and for each business, an inventory can mean different things.

However, for every business that handles inventory, it can be the biggest asset and one of the most important aspects of a business to make a profit.

Therefore, understanding what inventory is, different definitions of inventory, and examples of inventory as well as other important aspects that come with inventory handling is essential to successfully run a business.

What is Inventory?

Inventory is one of the biggest and most important assets company has. It refers to goods, items, merchandise, and component parts to be sold as well as raw materials uses in production to produce products or repair products in order to make a profit.

However, because inventory is such an important part of a business to make a profit, thus it’s important to have an understanding of key aspects of inventory such as inventory management which helps with having an effective way to purchase, receive, store, sell and dispatch inventory and turnover of inventory which is one of the primary sources of revenue generation and subsequently earnings for the company’s shareholders.

It also can include other items such as packaging, labels, and other important items for the company to effectively sell its products.

Inventory is also an accounting term that refers to counting or listing items of all stock in various production stages. By having precise numbers of items in inventory manufacturers and retailers can ensure they have enough stock to keep production running to build items or continue to sell items to generate the biggest profit.

Inventory Definition Across Different Industries

With that, because inventory is such a broad term and for many businesses inventory means something else, let’s also describe the various definitions of inventory based on different industries.

So here are some of the inventory examples:

Manufacturing

In the manufacturing industry, it is called manufacturing inventory or product inventory and it refers to all supplies, parts, and materials all the way to goods as manufacturers produce and sell products. Therefore, it’s not only the finished products but also the raw materials used in production, partially finished goods (work in progress inventory), and completed products ready to be packed and sold.

This means there are three types of manufacturing inventory, raw materials, work-in-progress inventory, and finished goods.

3 types of manufacturing inventory what is inventory

Example: In a clothing manufactory the inventory would include things like different types of fabric, buttons, threads, etc. for raw materials. For a work-in-progress inventory, this could be shirts without buttons, sleeves, or collars, and for completed goods inventory this would be the products such as jeans, shirts, pants, etc. ready to be shipped.

Service

The service industry is a large industry with many different services that can be provided to clients, from F&B, medical, accommodation, cleaning, financial, and many more different types of services industry we could mention.

And of course, each service industry has different inventories. However, in general, there is no exchange of physical goods or stock, then inventory is mostly intangible in nature. Therefore, the inventory in the service industry includes important steps, items, spaces, machines, and even people involved before completing a sale.

Example #1: In the hotel industry, the inventory could be the rooms and the equipment of the room such as phones, beds, etc. Therefore, vacant rooms are considered unused inventory. That same could apply to cinemas and theaters. Unused rooms can be considered unused inventory.

Example #2: In the F&B industry like restaurants, fast food chains, or coffees the inventory can include all the ingredients to cook or prepare the food or drinks. It can also include products such as liquors and sodas, sugar cubes for your tea, or even tea bags and other essential items to run your F&B.

Example #3: In-hospital emergency room, the inventory could be different protective clothing, syringe, and medicines, and in-hospital this could also be the rooms similar to the accommodation industry as each room can be considered as an inventory.

Retail

In the retail industry, the inventory means the stock of any item or resource whether it is retailing of FMCG, luxury bags, groceries, electrical appliances, cars, etc. that is displayed in the retail store. It is the physical stock of goods/items that a retailer keeps in store, storage, and warehouses for selling to customers when they come to the shop. It can also include spare parts and other items to provide repairs of the goods.

Example: In an electrical retail store this could include all the electrical appliances such as phones, laptops, screens, cooking appliances, etc., and the parts in case something gets broken.

Not all electrical stores are having spare parts as most of the time, any broken goods are under a manufacturing warranty. However, anything after, the store can also provide services to repair those appliances after the warranty ends.

Therefore, retail stores can have multiple different types of inventories within their stock based on the items they sell and the services they provide if any.

Inventory Valuation

Inventory valuation is an accounting practice to determine the value of a company’s inventory at the end of the accounting period to prepare a financial statement as this will help to put a financial value on unsold inventory. This is done because inventory is considered an asset for a business, thus it needs to be recorded on the balance sheets.

inventory valuation for what is inventory

Further, this value will help you to determine your inventory turnover and based on that you can better plan your inventory purchasing decisions.

The inventory valuation process is based on the costs incurred to acquire the inventory, get it ready for sale, and transportation to a retail store. The costs that can be included in an inventory valuation are direct labor, direct materials, factory overhead, freight, handling fees, and import duties.

And once this valuation appears on the business balance sheet it can also be used as collateral for loans and for evaluating the business value because, for most companies, inventories are the largest asset they have.

Types of Inventory

There are many different types of inventory and depending on the industry your business is in you might encounter some of these inventory types. It’s also important to understand all the different types of inventory so you can improve your inventory management.

So here we will describe the 14 different inventory types:

The four main types of inventory that are commonly used are:

1. Raw Materials:

These are all the components, subassemblies, and supplies currently in stock that are or will be used to produce products. After the product is completed the raw materials/components are unrecognizable and are completely in different forms or shapes. For example, sugar, cacao beans, and butter make your favorite chocolate bar.

2. Work In Progress (WIP):

WIP inventory is partially finished goods awaiting completion and it refers to the raw materials, labor, and overhead costs incurred for products that are at various stages of the production process. For example, laptop manufacturing can take several days to complete and assemble the entire laptop from adding the motherboard, graphic card, RAM cards, etc. to connecting the display, touchpad, keyboard, etc. Usually, Work-In-Progress is used for bigger projects that might take longer from a few days to months or years.

3. Finished Goods:

Finished goods inventory refers to all the items in the stock that are ready to be sold. For some, this could include packaged goods to be ready to be sold. For example, a packaged stack of papers is ready to be sold.
But here is a twist, for sellers it might be finished goods, but for buyers, this could be raw materials. Therefore, finished good is a relative term. For example, a stack of papers could be a finished product for paper manufacture (seller), but raw material for book manufacture (buyer).

4. MRO Inventory:

This includes all the items for maintenance, repair, and operations used in the production process at a manufacturing plant but are not part of the finished goods being produced. For example, spare parts and tools to repair machines, protective clothing, cleaning, laboratory and office supplies, computers, etc.

Let’s give an example of an Agile Dynamics Solution chocolate bar making business:

  • Raw Materials: Any material to produce the chocolate bar such as milk, butter, cocoa beans, or packaging.
  • Work In Progress: Unfinished products that are moving through production, such as cooling the chocolate bars in the freezer.
  • Finished Goods: Products that are ready to be sold. Chocolate bars are packed in packaging and boxes ready to be sold.
  • MRO Inventory: Protective clothing such as suits, gloves, glasses, and headphones. Then cleaning supplies to clean the machines and manufacturing plant and tools to do maintenance of machines.

After these four main types of inventory, there are also other types of inventory that you should know as well:

5. Work In Process:

This is similar to Work-In-Progress however it tends to be used for short-time production goods that are quickly completed and transferred to finished goods inventory. For example pens, small electronics, plastic boxes, etc.

6. Components:

These are similar to the raw materials inventory as components inventory are materials that are used to create or complete products, except they are recognizable items when the product is completed such as screws, keyboards, screens, etc.

7. Packing Materials:

These include any items your business uses to pack the products you sell, whether it is a squeeze bottle for ketchup, a tube for your toothpaste, boxes to put the tube with toothpaste in, and the boxes to deliver a large number of toothpaste to the retail shop.

8. Buffer Stock (Safety Stock):

This is an extra stock in your Warehouse to protect the business from short supply, supply disruptions, or any scenarios when in case of emergency the business stock has been kept in hand to continue selling or production. For example, keeping extra packaging, protective clothing, screws, or products to keep the production or retail not going out of stock.

9. Service Inventory:

In the service industry, there are certain stock inventories to provide its services. This can include hotel rooms, tables in restaurants to serve customers, hospital beds in hospitals, available appointment slots for using certain machines, tennis courts for tennis clubs, etc. For example, if you have 10 tables in a restaurant that accepts 2 hours booking apart and your restaurant is open 12 hours, then you have a daily inventory of 60 reservations. (Each table can be booked 6 times per day with a 2-hour slot in 12 hours, so 10×6=60)

10. Transit (Pipeline) Inventory:

These are goods or supplies that have already been shipped from the supplier warehouse but have not yet been delivered to the buyer. Whether you are a buyer or seller, you have to account for the inventory transit. For example, if you purchase from Shopee, Amazon, or any eCommerce store before it arrives at you, the inventory is considered under transit inventory. In B2B and long transit times, multiple T&Cs are responsible for this inventory to accurately display it in accounting.

11. Excess Inventory:

This is any item, product, component, raw materials, or other goods stored by a company and is not expected to be sold, used in production, or kept for a long time in the warehouse. For example, grocery stores purchased too many branded sauces that were predicted to be a big hit. But the demand was much smaller than expected and now the retail has too much sauce that is expensive to store.

12. Cycle Inventory:

These are the items that reseller, manufacturers, or wholesaler uses for their day-to-day business to meet regular orders. This stock covers sales and generates cash flows, which the company uses to pay creditors. For example, a grocery store has many staple products such as butter, milk, pastry, and many others. These products are expected to be sold on a regular basis based on forecast and historical data. Of course, cycle inventory can change according to the season.

13. Decoupled Inventory:

These are usually raw materials, parts, and other goods that are set aside as an extra inventory used by Manufacturers in case of any supply chain disruptions, slow production, unseen fluctuations, or shortages on the market in order to meet purchase orders and avoid any business disruptions. It basically acts as a buffer that allows you to continue sales and order fulfillment. For example, if you are manufacturing cars, then having decoupled chips to keep producing your smart cars in case of shortages will help you to keep producing cars even if no new chips are coming.

14. Theoretical (Book) Inventory:

This is all your inventory as per your records in your account books. This is then usually physically counted to ensure the book inventory matches the actual inventory. Usually in hospitality/F&B services, this is a very important practice as theoretical often does not match the actual inventory due to wastages or inaccuracies in portions.

Inventory vs Asset

The main difference between inventory and asset is that inventory is used to sell it to make a profit or produce products that are subsequently sold to make a profit while assets are considered an investment and are used to buy, transfer, store, manage or sell inventory and manage the business operation.

Simply put, inventory is what you sell to make a profit while an asset is what you own to run your business such as office, plant, lorry, forklift, furniture, equipment, etc.

Also in accounting, an inventory is recorded as a current asset as it is intended to sell it within 12 months. However, if the stock is not sold in 12 months, then it is considered a dead stock or obsolete inventory and is counted as a liability.

Therefore, inventory is what a company must sell to stay in business, and it is also a part of the asset, while the asset is a broad term, and it is considered an economic resource that can be both tangible and intangible forms and it is used to produce value for the organization.

Therefore, having centralized operation and using business management solutions where accounting software, inventory system, and sales software are integrated allows you to accurately manage your business operation, and financials and make the right decision.

For example, Dynamics 365 Business Central is an all-in-one enterprise resource management system for Small-Medium Size Businesses to centralize, simplify and automate their business processes across Finance, Supply Chain, Sales, Inventory and Warehouse, Customer Service, Manufacturing, and Projects.

Inventory Location

Inventory locations are used in every basic warehouse management system (WMS) to organize and easily find where inventory items are stored and picked from in a WMS.

The term location refers to the place where items are stored and drawn from. To make it easier systems allow you to configure the inventory location hierarchy with as many levels as are required.

Locations can be on-site locations such as headquarters and warehouses or they could be off-site locations like your contract manufacturer or finished goods distribution.

Why Do You Need Inventory Management?

As said, inventory is a company’s biggest asset it’s also very crucial to have proper inventory management to ensure company profitability and health as it helps to make sure you have the right amount of stock and avoid costly mistakes such as too much or too little stock, thus limiting the risk of stockouts, stock excess or inaccurate records.

The right inventory management system helps you to have the right balance in your inventory and helps you to provide important information on when to invest in more inventory to avoid overstock and deficit in the budget. Also, check out our guide on ERP Inventory Management.

Or not having enough stock and you compromise on customer experience by making them wait or losing on business when customers go somewhere else to get the item.

Also, public companies must track inventory as a requirement for compliance with Securities and Exchange Commission (SEC) rules and the Sarbanes-Oxley (SOX) Act. Companies must document their management processes to prove compliance.

With that, a close tab on the movement of inventory can make or break your business and that’s why entrepreneurs always emphasize effective inventory management. While a few business owners do understand the significance and cruciality of tracking inventory regularly, some fail to realize its importance making their business fall through the unseen cracks.

Learn more about Microsoft Dynamics 365 Inventory Applications

Dynamics 365 is a portfolio of business applications that meets organizations where they are—and invites them to digitally transform. Each app is designed to remove the barriers and eliminate silos within organizations by working together with existing systems—or the entire portfolio of Dynamics 365 apps—for outcomes you simply can’t get unless every part of the business is connected seamlessly. Dynamics  365 offers several options for an inventory management system, each to fit your needs. Contact us to get personalized suggestion based on your needs, budget and industry.

Microsoft Dynamics 365 Business Central- inventory management solution

Dynamics 365 Business Central is an all-in-one enterprise resource management System for Small-Medium Size Businesses to centralize, simplify and automate your business processes across Finance, Supply Chain, Sales, Inventory & Warehouse Customer Service, Manufacturing, and Projects.

Microsoft Dynamics 365 Supply Chain Management - inventory management system

Dynamics 365 Supply Chain Management transforms your manufacturing and distribution operations and predicts disruptions and responds fast by digitizing your supply chain, warehouse and inventory management, enhancing visibility, improving planning, and maximizing asset productivity.

Microsoft Dynamics 365 Commerce - Inventory Management System

Is Customer Automation and Customer Management system. Differentiate your brand by taking advantage of built-in intelligence to deliver faster, more personalized service and add value to every customer interaction.

Microsoft Dynamics 365 Field Service

Provides complete field Service Management including service agreements, predictive maintenance, preventative maintenance, work order management, resource management, product inventory, scheduling and dispatch, mobility, collaboration, customer billing, and analytics.

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