Accounting is an integral part of any business, and managing inventories is the blueprint of the accounting process.
This comprehensive guide will explore the different methods and strategies for managing inventories in accounting.
What Are Inventories In Accounting And How Does It Work?
Inventory is an important part of accounting that helps businesses keep track of their assets. It is the process of tracking and recording the purchase, sale, and use of products within a company.
Inventory accounting helps businesses understand how much stock they have and how much stock they need to order to meet customer demand.
By understanding inventory levels, businesses can also plan for future orders and ensure they are not overstocking or understocking their products.
Additionally, inventory accounting can help businesses identify potential issues with their supply chains and any discrepancies in pricing or delivery times.
Companies need to be aware of patterns in customer buying behaviour and item sales velocity. This helps them to decide how often they must replenish their stock and which items should be given the highest priority when it comes time for resupply.
Utilising this data can be beneficial in numerous ways, from better customer relations to improved cash flow and increased profits. This also helps reduce the loss of money through wasted inventory, stockouts and re-stocking delays.
The Importance Of Inventories In Accounting
Inventory control is an important aspect of accounting that can help businesses maximise profits.
With inventory control, companies can track their stock levels, order and purchase the right raw materials and supplies, and set accurate product pricing. It also helps to reduce the risk of losses due to theft or spoilage.
By taking advantage of inventory control in accounting, businesses can ensure they have the right amount of stock on hand when customers need it and avoid overstocking or understocking their shelves.
With appropriate measures in place for inventories in accounting, the company can be sure to meet customer needs while at the same time ensuring financial flexibility.
These internal and production controls guarantee that demand is met and finance remains effective.
If a company doesn’t possess enough inventory, they risk market share erosion and a decrease in profit from potential sales. However, it is also important to note that too much inventory for a long period can also run a risk of increased storage and spoilage costs and the threat of obsolescence.
If inventory management in accounting is done right, it should increase profits by lowering costs and encouraging turnover. This can lead to the improvement of cash flow, a reduction of stockouts, and an increase in customer satisfaction.
Additionally, it helps to prevent wasted inventory, reduces project delays, and improves payment management from suppliers and vendors.
Different Types Of Inventories In Accounting
There are four different types of inventory levels in accounting. These include raw materials, work-in-progress (WIP), merchandise and supplies, and finished goods.
Businesses use these four main categories to ensure efficient and effective inventory management. This not only keeps track of items currently in stock but also helps them easily identify items they might need in the future.
Raw materials
Raw materials are essential for manufacturing companies as they transform into finished products. The transformation process usually involves significant changes to the original raw material.
Components
Much like raw materials, components are necessary to make and finalise a product.
What makes them unique is that they remain easily identifiable even after the product is finished.
Work In Progress (WIP)
Work-in-progress inventory is the semi-finished goods that await completion and resale. It is also known as inventory on the production floor.
They include items such as raw materials or components, labour, overhead and packing materials.
Packing and Packaging Materials
This type of inventory includes three types. Primary packing is essential for the protection and usability of a product. Secondary packing is when the end product is packaged with labels and SKU details included.
Tertiary packaging refers to bulk packaging that’s used for transport.
Decoupling Inventory
Decoupling inventory is a valuable tool for companies of all sizes. It helps keep production lines running smoothly by providing extra resources to avoid costly work stoppages.
This type of inventory is particularly useful for businesses that operate in a Just-In-Time (JIT) fashion, as it allows them to maintain a lean inventory while still ensuring they have enough stock to meet customer demands.
Furthermore, this JIT inventory system with backflush costing can aid companies in maximising inventory costs. This is because goods are produced or received only when necessary.
Maintenance, Repair and Operations (MRO) Goods
MRO is a type of inventory which encompasses the parts, components, and equipment necessary for manufacturing a product or maintaining business operations.
Its importance is often overlooked but critical to the success of any organisation.
Safety Stock and Anticipation Stock
Companies purchase and store additional inventory, known as safety stock, to be ready for contingencies. The storage of safety stock may incur costs; however, it assures customer satisfaction.
Anticipation inventory comprises components, and products businesses buy to meet expected sales and production demands. This helps them stay one step ahead of their customers’ needs.
Many businesses stock up on safety stock to stay ahead of the curve and avoid running out of raw materials. This is especially true when a raw material’s cost rises or peak season sales are around the corner.
Finished Goods
Finished goods are products that have been prepared for sale and are ready to be marketed.
Cycle Inventory
To effectively manage storage costs, companies purchase cycle inventory in bulk quantities. This ensures they have the right stock on hand without incurring additional costs.
Service Inventory
Service inventory is a powerful tool for managers to measure and manage their businesses services. It allows them to track the number of services they can offer during a specific period, enabling better planning and forecasting. With this concept, managers can make informed decisions on how to allocate resources and optimise customer service.
Service inventory also helps identify areas of improvement that can be addressed to increase customer satisfaction and loyalty.
Transit Inventory
Transit inventory, or pipeline stock, is the merchandise travelling between the manufacturer, warehouse and distribution centre.It may require weeks to move from one facility to another.
Theoretical Inventory
Referred to as book inventory, theoretical inventory is the bare minimum of stock a business needs to keep the process running without waiting.
This concept is mainly utilised in production and food industries, where it’s calculated using the actual versus theoretical formula.
Excess Inventory
Excess inventory, commonly known as obsolete inventory, is unsold or unused items a company has stockpiled.
However, they must still bear the storage cost even though they aren’t expected to use or sell these items.
Effective Inventory Practices
Carry Safety Stock
Safety stock, or buffer stock, is designed to stay one step ahead of demand. This helps businesses guard against running out of materials or high-demand products.
If a company exhausts the supply they calculated, this safety stock will act as a fail-safe if there’s an unexpected surge in orders.
Encourage A Cloud-Based Management Programme
Cloud-based inventory systems provide real-time insights into products and SKUs globally, helping companies stay agile and responsive.
This data also helps them stay up-to-date with the latest trends in their industry.
Invest In A Cycle Count Programme
The advantages of cycle counting are numerous, from satisfying customers to helping
businesses save money and time. Not only that, but it also helps in maintaining accurate inventory records in the warehouse.
Make Use Of Batch/Lot Tracking
Maintaining and storing accurate records related to each batch of product produced is important. This information should be detailed and up-to-date for easy access when required.
With these insights, businesses can easily discern their products’ total expenditure and determine the expected durability.
Conclusion
Inventory management is essential as companies strive to improve their supply chain efficiency.
It provides a clear view of current stock levels, production requirements and customer needs, allowing businesses to ensure adequate resources are in place to meet customer demand.
With the right inventory management system in place, companies can easily manage their storage space and cash flow while ensuring that customer demands are always met.
FAQS
How do you calculate the average cost for inventories in accounting?
To figure out the average cost, add all the stock costs, and divide it by the number of items sold.
Is inventory an asset or liability?
It’s typically recognised and reported as a current asset on your balance sheet.
Products, materials and supplies you sell or use within a year of manufacturing are considered current assets and should be appropriately recorded in your books.
What is inventory count?
Taking inventory is an important task that involves counting and inspecting warehouse items.
This process’s outcome serves accounting purposes and provides a clear understanding of the assets and liabilities associated with it. This helps in long-term budgeting and decision-making.
Inventory counts are essential for business owners to stay on top of stock trends. Inventory managers can use this data to predict their demand and set aside a budget accordingly.
