Effective inventory management involves tracking stock levels, forecasting demand, and optimizing storage. By using precise tracking and organized processes, you ensure quick access to products and enhance your overall operational efficiency. In this guide, we’ll explore the different types of inventories, methods to enhance inventory management efficiency, and the role of mobile ERP solutions in optimizing inventory operations.
What is Inventory?
Inventory includes everything your business plans to sell, from raw materials to finished products. While this definition works, it’s helpful to extend it to include materials essential to your production process. Even if these items never reach customers, they’re vital to your operations and should be considered part of your inventory.
In short, inventory is the collection of goods and materials your business holds for resale, production, or internal use.
When your business is small, managing inventory might not seem crucial. But as it grows, so does the need for effective inventory management. Typically, systems evolve like this:
- Mental tracking
- Paper-based methods (e.g., sticky notes, notepads)
- Excel-based tracking
- Specialized inventory management software
Each stage offers better tools for handling increased inventory complexity. As your business grows, you might skip some steps and adopt advanced software with built-in inventory management.
Overview:
What are the 4 Types of Inventory?
Understanding the different types of inventories is essential for effective management. In a manufacturing context, inventory is generally categorized into four primary types:
1. Raw Materials
Raw materials encompass all the items your business uses to create finished products. These materials might be sourced externally, produced in-house, or obtained from suppliers. Raw materials are typically classified into two types:
i. Direct Raw Materials
Direct raw materials are the components directly used in the final product. These materials are easy to quantify and track, whether on a per-unit or per-batch basis.
ii. Indirect Raw Materials
Indirect raw materials are not part of the final product but are necessary for the production process. These materials are harder to trace to specific batches or units, making them more challenging to account for, though they are crucial for manufacturing.
For example, consider Tesla, Inc., which manufactures electric vehicles. To produce each vehicle, Tesla requires materials such as lithium, cobalt, nickel, and aluminum for its batteries. These components are quantifiable and directly involved in the final product, so they are categorized as direct raw materials.
However, Tesla also uses items like lubricants, cleaning agents, and maintenance tools in its manufacturing process. These are not part of the finished vehicles but are essential to the production process. Since it’s challenging to determine the exact quantity used per vehicle, these items are classified as indirect raw materials.
2. Work-in-Progress (WIP) Inventory
Work-in-progress (WIP) inventory includes all materials and products currently being worked on but not yet completed. This inventory can consist of both direct and indirect raw materials, as long as the product remains unfinished.
Let’s dive into our previous live example (Tesla, Inc.) once again. Each Tesla vehicle requires a variety of raw materials like lithium, cobalt, nickel, and aluminum for battery production. Once these materials are being assembled into batteries, they move from raw materials to WIP inventory. At this stage, the items are no longer categorized as raw materials but as part of the WIP inventory.
Managing WIP inventory is crucial because it represents capital tied up in the production process. Effective management of WIP can reduce lead times, streamline production flow, and boost overall efficiency.
3. Finished Goods Inventory
Finished goods inventory consists of all items that are fully produced and ready for sale or distribution. Depending on your workflow, this can mean slightly different things.
In a make-to-order process, products are ready for immediate shipment once completed. In contrast, with a make-to-stock approach, finished goods are stored in a warehouse until orders are received. Regardless of the method, finished goods inventory is straightforward to track and manage.
For example, at Tesla, Inc., once a vehicle is fully assembled and passes all quality checks, it becomes part of Tesla’s finished goods inventory. These vehicles are either shipped directly to customers or stored in a distribution center until they are sold.
4. Maintenance, Repair, and Operations (MRO) Inventory
MRO inventory consists of essential items used for maintaining, repairing, and supporting the manufacturing process. This includes everything from lubricants and cleaning supplies to spare parts for machinery. Although MRO inventory doesn’t directly impact production, it plays a crucial role in keeping your operations running smoothly. Effective management of these items ensures that your equipment stays reliable and minimizes the risk of unexpected downtime, ultimately maintaining the efficiency and continuity of your manufacturing process.
MRO Inventory Management 101: The Ultimate Guide
Different Methods to Improve the Efficiency of Inventory Management
Efficient inventory management is key to optimizing operations, reducing costs, and enhancing profitability. Several methods can be employed to improve the efficiency of inventory management such as:
- FIFO — first in, first out
- LIFO — last-in, first-out
- JIT — just-in-time
- ABC analysis
- Economic order quantity
- Average costing
- Cycle counting
- Safety stock inventory
- Perpetual inventory system
A brief overview of each strategy is outlined as below:
FIFO — first in, first out
FIFO (First-In, First-Out) is a popular inventory management method that ensures you use or sell the oldest products first. For example, if you run a grocery store and stock perishable items like milk, FIFO would mean you sell the milk that was received first before selling the newly stocked milk. This approach helps you minimize spoilage and avoid selling outdated products. It’s especially useful in industries with products that have a limited shelf life, as it ensures that older items are used before newer ones.
In accounting, FIFO gives you a clear picture of your inventory costs and levels by reflecting the original purchase prices of goods sold or used. This method helps you maintain accurate financial records and manage your inventory efficiently.
LIFO — last-in, first-out
LIFO (Last-In, First-Out) is an inventory management method where the latest items added to your inventory are sold before older stock. This means that when you sell products, you use the cost of the most recent purchases first. For instance, if you run a store and buy 100 widgets at $10 each in January and 100 more at $15 each in March, under LIFO, you sell the March widgets first.
During inflationary periods, this results in higher costs being assigned to the goods sold, reflecting the most recent, higher purchase prices. This can lead to lower reported profits and, consequently, lower taxes because you can deduct the higher costs of inventory from your taxable income. However, while LIFO can reduce your tax liability, it may also cause your financial statements to show outdated inventory values, potentially affecting your business’s perceived profitability and asset values.
Just-In-Time (JIT) Inventory Management
Just-in-Time (JIT) inventory management focuses on minimizing inventory holding costs by ordering stock only as needed for the production process. By synchronizing inventory with current demand, JIT reduces excess inventory and storage costs while enhancing cash flow and efficiency. For example, a car manufacturer using JIT might only receive parts when they are required on the assembly line, avoiding the costs associated with storing large quantities of inventory.
The benefits of JIT include reduced waste, lower holding costs, and improved cash flow. However, it demands a highly coordinated supply chain and can be risky if supply disruptions occur, potentially leading to production delays or shortages. Despite these challenges, JIT allows businesses to maintain optimal inventory levels and ensure products are available as needed without overstocking.
ABC Analysis
ABC analysis helps you manage inventory by categorizing items based on their importance. You sort inventory into three classes:
- A items: High-value, low-frequency items.
- B items: Moderate-value, moderate-frequency items.
- C items: Low-value, high-frequency items.
This method allows you to prioritize your efforts, focusing more on high-value items that are crucial but less frequently sold. For example, in a retail store, high-end electronics like smartphones would be classified as A items due to their high value and less frequent sales compared to everyday items like batteries, which would be C items due to their lower value and higher sales frequency.
By using ABC analysis, you can optimize stock levels, allocate resources more effectively, and improve overall efficiency. However, be aware that you may need to update classifications regularly to reflect changes in demand or market conditions.
Economic Order Quantity (EOQ)
Economic Order Quantity (EOQ) helps you find the ideal order quantity that minimizes total inventory costs, including both ordering and holding expenses. By using the EOQ model, you balance the trade-off between ordering too much or too little stock, which helps you manage inventory more cost-effectively.
For instance, if you run a retail store and need to stock a popular product, calculating the EOQ allows you to determine how many units to order at a time to minimize your costs. The EOQ formula, developed by economist Harold A. Hotelling, is:
Q = Square root of 2DKHQ
where:
H = Carrying costs
Q = Optimal order quantity
D = Annual demand
K = Ordering costs
While EOQ can help optimize inventory and reduce costs, it assumes constant demand and lead times, which may not hold true in a fluctuating market.
Average Costing
Average costing, or the weighted-average method, assigns a uniform cost to all inventory items based on the total cost of goods acquired divided by the number of items. To calculate the average cost per unit, use this formula:
Average cost=Total cost of purchases/Number of units purchased
For example, if you run a bakery and buy 100 bags of flour at $5 each and later buy another 200 bags at $6 each, you would calculate the average cost per bag as follows:
- Calculate the total cost: (100×5) +(200×6) =500+1200=1700
- Total number of bags: 100 + 200 = 300
- Average cost per bag: 1700/300=5.67
Every unit in inventory is valued at this average cost, which simplifies accounting and provides a consistent valuation for all inventory items.
Cycle Counting
Cycle counting involves regularly checking and balancing your inventory by physically counting specific items and comparing them to your records. Instead of conducting a full inventory count annually or quarterly, you perform smaller, more frequent counts throughout the year.
For example, if you manage a warehouse that stores electronics, you might schedule monthly counts for high-value items like laptops and quarterly counts for lower-value items like cables. This method helps you quickly identify discrepancies and errors, allowing for timely adjustments and accurate data for decision-making.
Cycle counting reduces the need for extensive inventory counts, helps catch mistakes early, and improves process efficiency. By implementing this approach, you can maintain better control over your inventory and address potential issues before they become significant problems.
Inventory Cycle Counts with Oracle | Best Practices | Webinar
Safety Stock Inventory
Safety stock is the extra inventory you keep on hand to protect against unexpected demand spikes or supply chain disruptions. This buffer helps you avoid stockouts, ensuring that your production or sales can continue without interruption.
For example, if you run a clothing store and anticipate higher customer traffic during the holiday season, you might maintain additional stock of popular items like winter coats. This extra inventory ensures that you can meet customer demand even if suppliers face delays or if sales exceed your forecasts.
While safety stock helps prevent stockouts and keeps operations smooth, it also increases carrying costs. Balancing the amount of safety stock, you hold is crucial to managing these costs while mitigating risks associated with inventory shortages.
Perpetual Inventory System
A perpetual inventory system keeps track of inventory in real-time by automatically recording sales, purchases, and usage through computerized POS systems or ERP software. This setup provides you with up-to-date inventory data, enabling better decisions about ordering and sales.
For example, if you run a chain of electronics stores, implementing a perpetual inventory system will let you monitor stock levels across all locations continuously. If a popular gadget sells out in one store, you can quickly adjust your orders to prevent stockouts and lost sales.
These systems offer significant advantages over traditional methods. They reduce the risk of stockouts and minimize overall inventory costs by providing real-time visibility into stock levels and turnover rates. To successfully implement a perpetual inventory system, consider the type of system that best fits your needs, select appropriate software and hardware, and ensure your team is trained to use the new system effectively.
Mobile ERP Solution in Optimizing Your Inventory Operations
Enterprise Resource Planning (ERP) systems have revolutionized inventory management by integrating all business processes into a single system. A mobile ERP solution takes this a step further by providing real-time access to inventory data and management tools from anywhere, at any time. Some of the key benefits that your organization can accrue by implementing a mobile ERP solution is as follows:
Real-Time Inventory Tracking
A mobile inventory management solution let you track inventory levels in real-time, keeping your information current. This capability is crucial for making informed decisions about purchasing, production scheduling, and order fulfillment. By using real-time tracking, you can reduce the risk of stockouts and overstocking and improve your demand forecasting.
Enhanced Visibility and Control
With a mobile ERP solution, you gain greater visibility and control over the entire inventory process. You can monitor inventory levels, track shipments, and manage orders directly from your mobile device. Increased visibility helps you make better decisions, improves efficiency, and reduces operational costs.
Streamlined Supply Chain Management
A mobile inventory management solution can seamlessly integrate with your sales, purchasing, and production functions to streamline your organization’s supply chain eco-system. This integration ensures that you and your team work with the same data, which reduces errors and improves coordination. This way, you enhance your organizational efficiency, reduce lead times, and boost customer satisfaction.
Improved Responsiveness and Flexibility
Adopting a good mobile inventory management solution enables your business to respond quickly to changes in demand or supply chain disruptions. With real-time data and mobile access, your managers can make adjustments on the fly, ensuring that operations continue smoothly. Improved responsiveness leads to better customer service, reduced downtime, and a more agile business.
From the above backdrop, Propel Apps, a leading digital transformation company has developed an intuitive, user-friendly mobile inventory management solution that perfectly fits your warehouse needs. Using this solution, you can streamline complex supply chain processes for Oracle EBS, Oracle SCM Cloud, and SAP S/4 HANA while efficiently capturing and maintaining your barcode inventory data. To know more about this solution, schedule a call with us for a free demo.
Final Thoughts: Types of Inventory
Managing inventory well is key to running a successful manufacturing business. By understanding different types of inventories, using smart management methods, and tapping into mobile ERP solutions, you can boost your operational efficiency, cut costs, and increase profits. Taking a proactive approach helps you stay ahead of customer demands, streamline production, and set yourself up for long-term success.
