What is an Inventory?
Inventory is an accounting term that refers to goods that are in various stages of being made ready for sale, including:
- Finished goods (that are available to be sold)
- Work-in-progress (meaning in the process of being made)
- Raw materials (to be used to produce more finished goods)
Inventory is generally the largest current asset – items expected to sell within the next year – a company has.
In order to ensure that all accounting records are up-to-date and accurate, businesses manually take an inventory count at the end of each accounting period, which is typically quarterly or annually. Companies that do a daily inventory count are considered to take perpetual inventory, because their count is always current.
Any difference discovered between the inventory count on the company’s balance sheet and what is actually on-hand is termed “shrinkage.” It’s the inventory that is missing, for whatever reason. Sometimes the inventory is lost, other times it is stolen.
One way to try and reduce the size of your on-hand inventory is to use a just-in-time strategy. Using a just-in-time approach means that materials are delivered just in time to meet current customer demand. As a result, you have less inventory sitting around, waiting to be produced or sold.
To be successful using just-in-time, you have to have an accurate idea of how much you’ll sell in between product deliveries. If you’re selling 250 pairs of shoes a week and you receive deliveries every Friday, ideally you’ll receive 250 this Friday, to keep up with demand. However, if demand picks up or declines in between deliveries, you can end up with problems.
Having too much inventory is risky because you run the risk of being stuck with merchandise that is obsolete or past its prime. You may have to mark it down to sell it, thereby reducing your profit margin.
But having too little inventory, or running short, is an issue, too. Running out of a product your customers want can lead to dissatisfaction and lost sales, especially if they opt to buy from another retailer that has the item in stock. You lose money because you didn’t have the inventory in stock.
While the object of just-in-time inventory is to reduce the need to store inventory – ideally, it would all be sold just as the shipment arrives – keeping accurate track of what you’ll need to meet demand is challenging, since consumer tastes can change quickly.