Definition of Inventory
Inventory refers to the goods or materials that a business holds for the ultimate goal of resale or production. It broadly encompasses raw materials, work-in-progress (WIP), and finished goods. Inventory is considered a major asset on a company’s balance sheet since it represents one of the primary sources of revenue generation and future earnings.
Types of Inventory
- Raw Materials: The basic inputs required for production.
- Work in Progress (WIP): Items currently being transformed into finished goods.
- Finished Goods: Products that are ready for sale.
Significance
Inventory management is necessary for ensuring that the actual quantities of goods align with the reported figures in a company’s books of account. It helps in determining the cost of sales and plays a pivotal role in profit calculations and liquidity management.
Examples
- Retail Business: A clothing store inventories clothes, shoes, and accessories that are available for sale.
- Manufacturing Company: An automotive manufacturer inventories steel, car parts (WIP), and finished cars.
- E-commerce: An online retailer inventories electronics, books, and furniture.
Frequently Asked Questions (FAQs)
1. Why is inventory considered an asset?
Inventory represents items that a business can sell to generate revenue. As such, it is listed as a current asset on the balance sheet.
2. What is the difference between perpetual and periodic inventory systems?
A perpetual inventory system continually updates inventory records, while a periodic inventory system updates records at specific intervals.
3. How does inventory affect the cost of sales?
Changes in inventory levels (beginning inventory vs. end inventory) are used to calculate the cost of goods sold, affecting the profit and loss statement.
4. Why is a physical inventory count necessary?
Physical inventory counts are necessary to ensure the accuracy of inventory records, uncover discrepancies, and adjust the books accordingly.
5. How does Just-In-Time (JIT) inventory system work?
A JIT inventory system minimizes the time items spend in inventory by ordering goods only as they are needed in the production process.
Related Terms
Raw Materials
The basic materials used in the production of goods.
Work in Progress (WIP)
Partially finished goods that are still in the production process.
Finished Goods
Completed products ready for sale.
Cost of Sales (Cost of Goods Sold - COGS)
The direct costs attributable to the production of the goods sold by a company.
Profit and Loss Account
A financial statement summarizing the revenues, costs, and expenses incurred during a specific period.
Current Asset
An asset likely to be converted into cash within one year.
Online References
Suggested Books for Further Studies
- “Accounting for Inventory” by Steven M. Bragg
- “Inventory Management Explained: A focus on Forecasting, Lot Sizing, Safety Stock, and Ordering Systems” by David J. Piasecki
- “Principles of Inventory and Materials Management” by Richard J. Tersine
- “Inventory Accuracy: People, Processes, & Technology” by David J. Piasecki
Inventory Fundamentals Quiz
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