| In business management, inventory consists of a list of goods and materials held
available in stock. An inventory can also be a self examination, a moral inventory.
Business inventory
Each country has its own rules about accounting for inventory; this article
concentrates on economic theory, United States financial accounting rules, and Eliyahu M. Goldratt's throughput
accounting. National boundaries do not limit economics, and throughput accounting functions independently of national regulations because it affects public
financial reports only indirectly.
Organizations in the U.S. define inventory to suit their needs within Generally Accepted
Accounting Practices (GAAP), the rules defined by the Financial Accounting Standards Board (FASB) (and others) and enforced by the Securities and Exchange Commission
(SEC) and other federal and state agencies. Inventory management affects organizations' internal operations through their
cost accounting methods. Nearly all goods feature printed bar codes
-- known as Stock Keeping Units or SKUs -- for their role in managing inventory.
While financial accounting uses standards that allow the
public to compare firms, cost accounting functions internally to an
organization and with much greater flexibility. A discussion of inventory from standard and theory of constraints-based (throughput)
cost accounting perspective follows some examples and a discussion of
inventory from a financial accounting perspective.
Inventory examples
While inventory is usually discussed in terms of goods for sale, manufacturing, service, and not-for-profit organizations also
have inventories of fixtures, furniture, supplies, ... that they do not intend to sell. Manufacturers', distributers', and
wholesalers' inventory is kept in warehouses. Retailers' inventory may be kept in a warehouse or in a shop or store accessible to
customers. Inventories that are not intended for sale to customers or clients may be kept in any premises an organization
uses.
Manufacturing organizations usually divide their "goods for sale" inventory into:
- materials and components scheduled for use in making a product (Materials and Components or Raw
Materials)
- materials and components that have begun their transformation to finished goods (Work in Process, or WIP)
- finished goods that are ready for sale to customers.
For example:
- Manufacturing: A canned food manufacturer's materials inventory includes the foods to be canned, empty cans and their
lids (or coils of steel or aluminum for constructing those components), labels, and anything else (solder, glue, ...) that will
form part of a finished can. The firm's work in process includes those materials from the time of release to the work floor until
they become complete and ready for sale to wholesale or retail customers. Its finished good inventory consists of all the cans of
food in its warehouse that it has manufactured and wishes to sell to food distributors (wholesalers), to grocery stores
(retailers), and even perhaps to consumers through arrangements like factory stores and outlet centers.
- Logistics or distribution includes the owners (wholesalers and retailers), manufacturer's agents, and
transportation channels an item passes through between manufacture and purchase by a final consumer. At each stage, goods belong
(are assets) to the seller until the buyer accepts them. Distribution includes four components:
- Manufacturers' agents: Distributors who hold and transport finished goods for manufacturers without ever owning
it. Manufacturers' agents' inventory is called materiel to differentiate it from
goods for sale.
- Transportation: The movement of goods between owners. Goods in transit are
owned by the seller until the buyer accepts them. Sellers or buyers may transport goods but most transportation providers act as
the seller's agents.
- Wholesaling: Distributors who buy goods from manufacturers and other suppliers (farmers, fishermen, etc.) for resale
work in the wholesale industry. A wholesaler's inventory consists of all the
products in its warehouse that it has purchased from manufacturers or other suppliers. A produce wholesaler (or distributor) may
buy from distributors in other parts of the world or from local farmers. Food distributors wish to sell their inventory to
grocery stores, other distributors, or possibly to consumers.
- Retailing: A retailer's inventory of goods for sale consists of all the products on its shelves that it has purchased
from manufacturers or wholesalers. The store attempts to sell its inventory of soup, bolts, sweaters, or other goods to
consumers.
Accounting perspectives
Financial accounting
An organization's inventory can appear a mixed blessing, since it counts as an asset
on the balance sheet, but it also ties up money that might serve for
other purposes and requires additional expense for its protection. Inventory may also cause significant tax expenses, depending
on particular countries' laws regarding depreciation of inventory. (See Thor Power Tools Decision.)
Inventory appears as an asset on an organization's balance sheet because the organization can turn it into cash by selling it.
Some organizations hold larger inventories than their operations require in order to inflate their apparent asset value and their
perceived profitability.
In addition to the money tied up by acquiring inventory, inventory also brings associated costs for space, for utilities, and
for insurance to cover staff to handle and protect it, fire and other disasters, obsolesence, shrinkage (theft and errors), and
others. Such holding costs can mount up: between a third and a half of its
acquisition value per year. An organization that reduced its inventory by $1,000,000 would add that amount to its net income, an
attractive prospect that helps to explain the popularity of programs like Just
in time (JIT) inventory.
Businesses that stock too little inventory cannot take advantage of large orders from customers if they cannot deliver. The
conflicting objectives of cost control and customer service often pit an organization's financial and operating managers against
its sales and marketing departments.
Sales people, in particular, often receive commission payments, so unavailable goods may reduce their potential personal
income.
Standard cost accounting
Standard cost accounting uses ratios called efficiencies that compare the labor and
materials actually used to produce a good with those that the same goods would have required under "standard" conditions. As long
as similar actual and standard conditions obtain, few problems arise. Unfortunately, standard cost accounting methods developed
about 100 years ago, when labor comprised the most important cost in manufactured goods. Standard methods continue to emphasize
labor efficiency even though that resource now constitutes a (very) small part of cost in most cases.
Standard cost accounting can hurt managers, workers, and firms in several ways. For example, a policy decision to increase
inventory can harm a manufacturing managers' performance
evaluation. Increasing inventory requires increased production, which means that processes must operate at higher rates. When
(not if) something goes wrong, the process takes longer and uses more than the standard labor time. The manager appears
responsible for the excess, even though s/he has no control over the production requirement or the problem.
In adverse economic times, firms use the same efficiencies to downsize, rightsize, or otherwise reduce their labor force.
Workers laid off under those circumstances have even less control over excess inventory and cost efficiencies than their
managers.
Many financial and cost accountants have agreed for many years on the desirability of replacing standard cost accounting. They
have not, however, found a successor.
Theory of constraints cost accounting
Eliyahu M. Goldratt developed the theory of constraints in part to address the cost accounting
problems in what he calls the "cost world". He offers a substitute, called throughput accounting, that uses throughput (money
for goods sold to customers) in place of output (goods produced that may sell or may boost inventory) and considers labor as a
fixed rather than as a variable cost. He defines inventory simply as everything the organization owns that it
plans to sell, including buildings, machinery, and many other things in addition to the categories listed here. The only variable
costs in throughput accounting are the operating expenses like
materials and components that vary directly with the quantity produced.
Finished goods inventories remain balance sheet assets, but labor
efficiency ratios no longer evaluate managers and workers. Instead of an incentive to reduce labor cost, throughput accounting
focuses attention on the relationships between throughput (revenue or income) on one hand and controllable operating expenses and
changes in[inventory on the other. Those relationships direct attention to the constraints or bottlenecks that prevent the system from
producing more throughput rather than people who have little or no control over their situations.
See also
Manufacturing, Distribution, Logistics, Transportation, Wholsaling, Retailing, Accounting, Cost accounting, Throughput
accounting, Eliyahu M. Goldratt, List of theory of constraints
topics, Vendor Managed Inventory, Economic order quantity
Moral inventory
Often in the course of 12 step programs, members say they are taking an inventory. Much like an inventory of goods and
services detailed here, it is a balance sheet of attributes. It might list such things as thankfullness, humility, acceptance, trust, forgiveness and restitution. Addicts use these inventories as a moral compass and guide for where they are in recovery.
Other uses of inventory
- In some role playing and other computer games,
inventory refers to item storage available to characters.
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