Inventory facts for kids

Electronics inventory

Inventory (also called stock) is a term for all the goods and materials a business has. These items are kept for different reasons. They might be for selling later, for making other products, or for using up in the business itself.

Inventory management is all about keeping track of these goods. It helps businesses know where their items are and how many they have. This is important for making sure things run smoothly, whether in one building or across many locations in a supply chain.

The idea of inventory isn't just for factories. It also applies to service businesses and projects. Think of it as "all the work done before a product is finished or a service is completed." For example, in a factory, inventory includes raw materials, partly finished items, and finished products ready to sell. In a service business, it could be information that's partly processed before a service is delivered.

Why Businesses Keep Stock

Businesses keep inventory for several important reasons:

• Time: There are often delays in getting supplies from one place to another. So, businesses keep some stock on hand to use during these waiting times. This helps them avoid running out of things.
• Seasonal Demand: Sometimes, people want more of a product at certain times of the year, like ice cream in summer or holiday decorations. Businesses build up stock beforehand because their production can't always change quickly.
• Uncertainty: It's hard to know exactly how much customers will want or when supplies might be delayed. Inventory acts as a safety net to handle these unexpected changes.
• Economies of Scale: Buying, moving, and storing items in large amounts can save money. It's often cheaper to buy a big batch of something than many small ones. This is why businesses keep inventory.
• Value Increase: Some products actually get better or more valuable if they are stored for a while. For example, some drinks like beer need time to age before they are ready.

These reasons apply to almost any business or product.

Special Terms for Inventory

• New old stock (NOS): This term is used for items that were made a long time ago but have never been used. Sometimes, these items are not made anymore, so NOS might be the only way to find them.

Types of Inventory

Here are some common types of inventory:

• Safety Stock: This is extra inventory a company keeps. It helps prevent running out of products if there's a sudden increase in demand or a delay in getting new supplies. It's like a backup supply.
• Reorder Level: This is the point when a company decides to order more stock. Some companies reorder when their stock drops below a certain amount. Others reorder at regular times, like every month.
• Cycle Stock: This is the regular inventory used in batch production. It's the stock available for use, not counting the safety stock.
• De-coupling Stock: This is a buffer of stock kept between different machines or steps in a production process. It helps keep the work flowing smoothly, so one machine doesn't have to wait for another.
• Anticipation Stock: This is extra stock built up for times when demand is expected to be higher. For example, a company might make more ice cream before summer.
• Pipeline Stock: These are goods that are still being transported or distributed. They have left the factory but haven't reached the customer yet.

Inventory Examples

While people often think of inventory as goods for sale, many organizations also have inventory they don't plan to sell. This includes things like furniture, equipment, or supplies. Manufacturers and distributors often keep their inventory in warehouses. Retailers might have inventory in a warehouse or right in their shop for customers to see.

Here are some specific examples:

Manufacturing

Imagine a company that makes canned food.

• Raw materials would be the ingredients for the food, empty cans, lids, and labels.
• Work in process (WIP) would be the food being prepared in large vats, or cans that are filled but not yet labeled.
• Finished goods would be all the filled and labeled cans of food ready to be sold to grocery stores or distributors.

Capital Projects

In big projects like building a bridge or an oil rig, "work in process" can be a type of inventory. This includes physical items like materials and parts, but also things like partially finished engineering designs.

Virtual Inventory

A "virtual inventory" lets different users share common parts. This is helpful when parts are needed quickly but not many people need them at the same time. It also allows distributors to ship goods directly to stores, even if the stock is in a different warehouse.

Costs of Inventory

Keeping inventory isn't free. There are several costs involved:

• Ordering Cost: The cost of placing an order for new stock.
• Setup Cost: The cost of setting up machines to produce a new batch of goods.
• Holding Cost: The cost of storing inventory. This includes warehouse space, utilities, insurance, and the risk of items becoming old or getting stolen. These costs can be quite high, sometimes a third to half of the item's value each year!
• Shortage Cost: The cost of running out of stock. This can mean lost sales or unhappy customers.

Businesses try to balance these costs. If they have too little inventory, they might miss out on sales. If they have too much, it costs a lot to store and manage.

Inventory Proportionality

This is a smart way to manage inventory. The main goal is to have just enough stock of every product so that they all run out at about the same time. This means there's no "extra inventory" of one product left over when another runs out. Why is this good? Because the money spent on that extra stock could have been used better elsewhere.

This method also aims to keep inventory levels as low as possible. By using good demand forecasting (predicting what customers will want), businesses can manage their stock more accurately.

Where It's Used

Inventory proportionality works best for products that customers don't see directly. For example, gasoline in underground tanks. Customers don't care if the tank is full or nearly empty. This method helps gas stations balance the different types of fuel they have, making sure they don't have too much of one type sitting unused. This saves money because gasoline is expensive.

This idea was inspired by the "just-in-time" system used by companies like Toyota. They aim to have parts arrive just when they are needed for production, reducing the need for large inventories.

Understanding Inventory for Business Decisions

Around the 1880s, factories started making many different products instead of just one type. This made it harder for managers to know how different products affected overall profits. They needed to understand the true cost of each product.

Later, around 1900, there was a greater need for financial reports. This meant that how inventory was valued for financial reporting became more important than how it was valued for internal management. This is still often true today.

For financial reporting, there are two basic formulas:

1. The cost of inventory at the start of a period + new purchases + production costs = total cost of goods available.
2. Total cost of goods available − cost of inventory at the end of the period = cost of goods sold.

These formulas help businesses report their inventory value and calculate how much profit they make from sales.

Managers are often interested in the inventory turnover ratio. This tells them how many times their inventory is sold and replaced in a year.

• Inventory turnover ratio = Cost of Goods Sold / Average Inventory

A higher turnover ratio usually means a business is managing its inventory well. For example, a factory that goes from turning its inventory over 6 times a year to 12 times a year has likely improved a lot. This means less money is tied up in stored goods.

New business models like Just in Time (JIT) Inventory and Vendor Managed Inventory (VMI) try to keep less inventory on hand and increase how often it "turns over."

Modern inventory management often uses online systems. These systems help businesses see all their stock, work together with other companies, and use real-time information to manage orders better.

Accounting for Inventory

Every country has its own rules for how businesses should account for inventory. These rules fit with their financial reporting standards. For example, in the U.S., businesses follow rules set by the Financial Accounting Standards Board (FASB).

Inventory is an asset on a company's balance sheet because it can be sold for cash. However, it also ties up money and costs money to protect. Inventory can also lead to tax expenses depending on the country's laws.

FIFO vs. LIFO Accounting

When a business sells goods from its inventory, the value of the inventory account goes down by the cost of goods sold (COGS). If the cost of items has changed over time, accountants need a way to decide which cost to use. Two common methods are:

• FIFO (First In, First Out): This method assumes that the first items bought into inventory are the first ones sold.
• LIFO (Last In, First Out): This method assumes that the last items bought into inventory are the first ones sold.

The method chosen can affect a company's reported profit and how much tax it pays. For example, during times of rising prices, LIFO can make a company report lower profits, which might mean lower taxes. Because LIFO can sometimes make a company's financial picture look different, many countries outside the U.S. do not allow it.

Distressed Inventory

Distressed inventory (or expired stock) refers to items that are difficult or impossible to sell at their normal price. This might be because they are past their expiry date, out of fashion, or simply old and no longer popular. For example, old newspapers, obsolete computer equipment, or clothes from last season.

In 2001, a company called Cisco had to write off $2.25 billion worth of inventory because of duplicate orders. This was one of the largest inventory write-offs in business history.

Stock Rotation

Stock rotation is when businesses regularly change how their inventory is displayed. This is common in stores, especially those selling food. For instance, supermarkets might move products around. Why? Because regular customers often go straight to the items they want without looking at anything else. By moving things, stores hope customers will look around more and discover other items they might want to buy.

Inventory Credit

Inventory credit means using your stock as collateral to get a loan. This can be very helpful for businesses, especially in places where it's hard to use other things, like land, as collateral. It's not a new idea; it was even done in Ancient Rome!

For this to work, banks need to be sure that the stored products will be available if they need to take them. This means there must be reliable, certified warehouses. Banks also need to figure out how much the inventory is worth. Because prices can change quickly, banks usually don't lend more than about 60% of the inventory's value at the time of the loan.

See also

In Spanish: Existencias para niños