What is Inventory？

Inventory is all the goods available for sale in a company's store or warehouse, as well as the existing raw materials used to make these products。Inventory includes products that have been completed and are available for purchase as well as those that are still in production。Items that the company does not intend to sell, even in stores, are not part of its inventory。For example, a clothing company may have dresses that are part of its inventory, but the mannequins used to display them are not。Inventory is treated as a current asset because the company continually sells inventory, so it is usually converted to cash within a year。

What are the different types of inventory?？

Companies can have many different types of inventory, but there are three main categories:

1. Raw materials are things that a company uses to make products that are subsequently sold。Back to Apple's example, the silicon used to make computer chips is a raw material。
   Work-in-progress includes anything that is not a raw material but is not ready to be sold to consumers.。When Apple converted silicon into computer chips but had not yet built those chips into computers, computer chips were work in progress。
   A finished product is anything the company is prepared to sell to customers, including laptops, phones, accessories, and everything else you can buy at the Apple Store。

What is Inventory Turnover？

Inventory turnover is a popular ratio that measures how often a company sells all its goods and replaces them with new ones.。The higher the company's inventory turnover, the more frequently it changes its inventory for sale。Investors use this ratio, along with other ratios, as a quick way to understand the financial health of the business。

However, this figure is not an accurate representation of the company's inventory。Businesses may have some goods that have been waiting to be sold for years, while others are selling fast enough to cover losses。Still, the ratio doesn't give investors an idea of how quickly a company sells its products。

How to Calculate Inventory Turnover Ratio？

There are two formulas for calculating inventory turnover.

Inventory Turnover = Cost of Sales / Average Inventory

Inventory Turnover = Sales / Average Inventory

Cost of sales refers to the direct expenses associated with the manufacture of goods for sale, including labor and materials.。To arrive at the average inventory, you need to subtract the ending inventory from the opening inventory and divide by two (the average is used to take into account the fact that inventory levels may vary seasonally)。

Both ratios can show the number of times a company has sold inventory and replaced inventory in a specific time period (for example, a year)。Low turnover may mean that the company is producing too many goods or not selling enough, while high turnover indicates strong sales or that the company is out of stock。

Why Inventory Turnover is Important？

There are several reasons why investors are concerned about inventory turnover。First, the cost of holding large amounts of inventory for a long time can be high, and companies must build or rent warehouses to store semi-finished or finished products; losses due to damage or theft are more likely; and certain products (such as electronic products) may become obsolete if new models are released。This risk varies by type of business。Grocery stores have more to worry about spoiling than hardware stores, and tech companies are more likely to make their merchandise obsolete than bookstores。

On the other hand, a high inventory turnover may indicate a high demand for the firm's goods。This is a good thing for any business that sells to consumers, but it can also mean that the company is not producing enough to meet this demand。

In order to increase turnover, companies can study the amount of inventory in each store or in transit (from warehouse to store or from production to warehouse)。These numbers are useful when designing a supply chain or deciding which items to send to a particular store。

How to calculate inventory balance？

The inventory balance is the total value of all the company's inventory, including raw materials, work-in-progress and finished goods.。This figure usually appears on a company's balance sheet, which is a financial document that lists all of the company's assets and liabilities。

Companies can use several different strategies to calculate inventory value:

• First-in, first-out (FIFO): A company assumes that goods are sold in the order in which they are manufactured or purchased。If a company produces 100 DVDs for $10 each, and 100 DVDs for $20 each, $10 will be deducted from its inventory for each of the first 100 DVDs, regardless of which disc is actually sold。$20 will be deducted for the next 100 DVDs sold。
  Last-in, first-out (LIFO): Companies make the opposite assumption - the last item purchased or manufactured is sold first.。In the example above, the first 100 sales would reduce the company's inventory by $20 each。The next 100 sales will reduce its inventory by $10 each.。
  Weighted Average Cost (WAC): The average cost of using a good。In the previous example, the company deducts the average cost of a DVD ($15) from its inventory value each time it sells。

What are the benefits of inventory management?？

Inventory management is the control of a company's inventory, from the purchase of raw materials to the production and sale of finished products.。Inventory managers have two jobs: First, their goal is to ensure that there are always items available when customers want to buy。No Apple store should run out of iPhones or risk losing sales。Second, inventory managers try to keep as little inventory as possible while meeting demand.。The less inventory a company holds, the lower the associated costs。

Companies can use multiple inventory management strategies。Some companies use just-in-time (JIT) inventory systems, in which raw materials arrive at the production facility accurately when the production facility is ready for use。Similarly, finished products are shipped to the store based on forecasted sales to minimize the amount of inventory waiting for sale。This type of system can reduce inventory holding costs, but if the goods do not arrive at the right time, it may cause a slowdown in production or loss of sales。

Another inventory management strategy is called direct selling.。Instead of storing product inventory in stores, manufacturers or wholesalers ship goods directly to customers when they buy, and household goods retailer Wayfair is one of the companies that use the agency shipping model。

Good inventory management can improve the efficiency of the company, reduce the cost of holding inventory and increase the turnover rate, which will make the company more flexible and may generate greater profits。Poor inventory management can increase costs for the company by increasing wear and tear (theft of goods by employees or customers), damage, or scrap。When the product is out of stock, it may also lead to loss of sales。