Understanding Inventory: Definition, Types, and Examples for Small Business Owners
February 20, 2023
Do you have chaos at the core of your business? Are you in a constant state of disorganization, scrambling for an open bin or rummaging through crowded shelves to find something you really need?If you answered 'yes' to any of these questions, then you have too much inventory. And don't blame yourself: our latest research found that 50 percent of US respondents did not feel confident in their ability to manage inventory.
Inventory management is essential for any business. Good news though: you can pick one and how you handle it will majorly determine your profit level. You are already safe, we have simplified the process for you. This is an inventory meaning and type guide for you.
What is Inventory?
Inventory is the petty cash or the products that a company possesses for production, sale or use. It includes raw materials, work in progress materials and finished goods ready for sale or use. Inventory management plays an important role in business, especially for small scale entrepreneurs to maintain the optimum stock levels, avoid stock-outs, minimize holding costs and increase customer satisfaction.
Understanding of what constitutes inventory for the specific business
This is necessary in order to properly manage inventory, and to avoid common mistakes such as overstocking or running out of key products.
Types of Inventory:
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Raw Materials:
Raw materials are the basic substance that initially go to a product during the process of production or manufacturing. They could either be supplied by external sources or be produced in-house, depending on the setup.
Raw materials are a natural resource, such as wood, cotton or petroleum. Products are raw materials that have been processed into finished goods, such as steel, plastic or chemicals.
For small companies that produce their own goods or make customized products, keeping a stock of raw materials ensures they have the necessary materials to run smoothly and meet customer demand.
Having a well-established supply chain for raw materials, and distributors who they have a good relationship with, will mean that small businesses can work on a speedy basis, without the worry that production delays or shortages will be the cause of a problem.
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Work-in-Progress (WIP):
Work-in-progress inventory is raw material, semi-finished goods or finished goods that are in the process of being manufactured or assembled but are not yet completed. This consists of goods in process – partially completed finished goods, or subassemblies or components that are not yet complete but are in some stage of production.
This is especially true for companies with products that follow complex production processes, which may have multiple steps. Rather than relying on final inventory figures, and scrambling to address a critical shortfall after the fact, work-in-progress inventory management helps companies track each step in the production of a given product line, identifying when a bottleneck or a delay has occurred, and giving them an opportunity to rectify the problem before orders arrive late.
Work-in-progress inventory management can track things such as labor hours, machine hours and other production elements as well. Information gathering and analysis helps to gain a perspective of operations that can potentially lend itself to a greater degree of control over business costs. For example, a company may come to realize that they have excess in some department leading them to reconsider the demand for workers they originally staffed.
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Finished Goods:
A finished good, meanwhile, is a product that has finished going through the production process (also known as manufactured or processed goods), and is ready to be purchased by the end customer, whether for personal use or resale. Finished goods may comprise physical products such as electronics, clothes, furniture and food. These can be further categorized into trading goods (products for the end customer), durable goods (any physical item designed to last for years), and non-durable goods (any physical item but with a life span of less than a year). Upon purchase, these finished goods are referred to as 'stock'. Other finished goods, such as services, lack physical form and include things such as software licenses and digital downloads.
Particularly for small-to-medium retail and e-commerce businesses, managing finished goods inventory is paramount in order to avoid tying up capital and adding on extra holding costs due to overstocking, while understocking can lead to lost sales and upset customers.
Answer:
To maintain finished goods inventory that suits customer demand as well as stock available, small business balanced approach in stocking up. By keeping a close watch on the sales numbers over the years, how the market behaves, as well as forecasting techniques, businesses can decide on restocking levels and ensure that customers can always get hold of desirable goods.
Examples of Inventory Management:
So now look at the example on the RHS: now we see how different businesses handle inventory to optimize the business outcomes:
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Retail Store:
For example, a small clothing store selling through a retail outlet has to plan its inventory adequately so that it is able to display the best mix of products to the customer on a daily basis. By analyzing past sales pattern, future sale trend can be estimated, which will enable the store to manage its purchasing and reordering to control the stock level, thereby preventing overstocking or stockout.
Inventory management software can also be used to enhance the efficiency of inventory management operations in retail stores. This kind of software can automate tedious tasks for inventory management such as inventory counts, purchasing and stock analysis such as portions, trends and reorder points.
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Restaurant:
The restaurant needs to keep track and ensure that the perishable items in inventory (particularly food and beverages) are not wasted or become rancid. Therefore, it should adopt a rigid system of first-in, first-out (FIFO) in order to use-up the oldest ones first.
On the other hand, if variations in FIFO are of no concern, regular inventory counts and reconciliations can reveal theft, a problem with spoilage or bad record-keeping right away. restaurant owners can react to inventory-variance reports by identifying discrepancies between actual inventory levels and recorded ones.
Good supplier management also goes a long way in ensuring fresh ingredients are available for restaurants on a timely basis. Maintaining stable supplier partnerships, assessing their dependability and consistency, and tracking order delivery standards would ensure restaurants maintain optimal inventory levels while ensuring a smooth operation.
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Manufacturing Company:
An example is a small furniture-making company that manufactures to order. To keep cash flow high, the company's managers must keep a close eye on raw materials inventory and relate well with suppliers so as to always have materials on hand when orders come in. They must always be fully aware about how long it will take to receive materials.
Frequent monitoring of levels of inventory and a robust ordering system might help to avoid production delays in this manner, as would forecasting of customer orders and production schedules to prevent stockouts in the inventory of raw materials.
For instance, if a manufacturing company receives an order for, say, some special furniture, it can step ahead of time to place a procurement order for the necessary raw materials to prevent any leads in the production timetable. Through balancing lead and production times, companies can find the sweet spot for operating optimally and meeting customer demand.
Small Business Inventory Management:
Effective inventory stock could be the key to a small business's success. Here's an easy-to-read staff-training text that gives you some simple tips on how you can manage your inventory more effectively. tip#1. Work with your suppliers to reduce inventory costs. tip#2. Create a demand schedule that aligns with your budget. tip#3. Use analytical data to create a plan to prevent stock shortages.
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Establish Inventory Levels:
Calculate optimum stock levels for each inventory item that will enable you to fulfill all expected customer demand but avoid both understocking and overstocking given your lead times and storage capacity.
By analyzing historical sales data and market trends, entrepreneurs can exploit movements in demand by increasing stock levels whenever demand is high and reducing stock when demand is low. Besides contextual data, implementing inventory forecasting techniques can dramatically improve the accuracy of stock levels.
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Implement Inventory Tracking Systems:
Record all inventory moves using a barcode scanner or inventory-management software: By scanning the item into and out of your inventory system, you can generate a real-time record of inventory levels in your system, quickly identify errors or problems, and help you place orders more efficiently.
That encompasses sophisticated inventory management software with functions that include automatic stock alerts, reordering, integration with sales channels and reporting, as well as metrics on inventory turnover, stockouts, and other KPIs.
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Conduct Regular Audits:
Perform 'physical' inventories at regular intervals to make sure the inventory that you think is on your shelves actually matches your recorded inventory levels. This will tell you if your stock levels have been lost, stolen from your records, or even if your records just aren't accurate.
Cycles may be regular, such as on a weekly or annual basis, or done whenever you suspect that your inventory numbers may be skewed. Using this metric and conducting regular audits will maintain the accuracy of your inventory data and help you deploy strategies to improve your inventory management.
One of the concepts that a small business owner must get is the definition of inventory as well as examples that help a business build a larger inventory. As a small business owner, I will explain the different inventory definition types and examples of each type. I find it important to understand inventory basic definitions as well as types of inventory and models. With these three inventory elements, a small business owner like myself will organize or run our business more effectively.
However, be assured that once you gain possession of their inventory the company will see increased profits, greater customer satisfaction and, ultimately, success. If you would like to learn more about inventory control, contact a consultant today.
