What is Inventory?

Published by Thomas Herold in Accounting, Corporate Finance, Trading

'Inventory' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Inventory refers to a collection of items that are an important part of any firms’ assets. These finished goods, products which are being built, and even raw materials constitute items that the company will sell. As such, analysts often consider inventory to be among the most crucial assets of companies since it is the sale of such goods that constitutes the main revenue generating sources. This leads to the corporate earnings which ultimately accrue for the good of the company stake holders.

Such inventories can be in a range of stages of completion, so long as the corporation keeps them on its company premises. It is also possible to have this on consignment. Consignment refers to a deal where the firm holds its goods at locations that are third party owned and operated. The company still maintains the ownership all the way to the point where it sells the goods.

Corporations report their inventories on their balance sheets. They do this beneath the category of current assets. Inventories are the intermediary stage standing in between order fulfillment and manufacturing. As these inventories become sold off, their carrying cost moves under the category for cost of goods sold found on the income statement.

Three different parts of inventories are broken out beneath this account on the statement. These are finished goods, works in progress, and raw materials. The finished goods prove to be those final products which have completed production processes. The business can put them up for sale. There are so many examples of this type of goods. Finished trains, boxed up electronics, and available to ship airlines are some of them. When retailers purchase such goods to resell them, they utilize the name of merchandise. Merchandise covers countless items which stores sell such as jewelry, clothing, and electronics that the retailers decide to stock.

Under the category of works in progress are a range of goods. These would still be under the manufacturing process to change them into soon to be completed goods. Examples of this include a ship under construction, sweaters which are half knit, and cars that are partially assembled.

Raw materials are those items which become a component in the production process. They are the source materials of the finished goods. Airline manufacturers would purchase steel, refineries would buy crude oil, and chocolate companies would buy sugar and cocoa.
There are also three different ways to value inventories as accountants measure them. FIFO First In, First Out means that their cost basis for the goods relies on the materials which the firm bought first. The last inventory would have carrying costs that relied on the last bought materials for its basis. There is also a LIFO last in, first out method. This does just the opposite. Goods’ costs depend on the pricing of the materials bought last, with other inventory having earliest purchased materials as the cost basis. The last methodology utilizes a weighted average for cost basis. Goods’ cost sold and inventory alike become based on the materials purchased average cost for the entire period.

Inventory management is a critical concept for any business that wishes to be profitable. Those companies which hold a great quantity of inventory will run afoul of expensive storage costs, spoilage possibilities, and their goods gradually becoming outdated. It is similarly a problem to not have sufficient inventories of goods. Companies can miss sales and possible market share gains when they do not possess enough goods to sell. This is why the near-science of inventory management attempts to predict and strategize so that these costs can be minimized and goods may be constructed and obtained as they are required. One of these effective management process systems is called the JIT just in time inventory system.

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The term 'Inventory' is included in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.