The management of an inventory may appear to be a difficult and time-consuming task, but if done in the right way and with the appropriate tools, it can be a breeze.
This post will cover some of the fundamentals of inventory management, as well as how to get started with the process. For those who are interested in acquiring additional knowledge, we will also supply some useful advice and references.
Continue reading this article if you are interested in learning more about managing your inventory.
Keep in mind that this content is intended to be general in nature, and is not personal financial advice. You should always consult with an accountant, finance or registered tax specialist to ensure that you are getting the right advice.
Chapter 1: What is inventory?
When you are a business owner, one of the most significant purchases you will make is for your inventory. It is the raison d’être of your company’s existence.
What is inventory, in the first place?
What your company purchases in order to resale to end users is referred to as its inventory, which is also sometimes referred to as stock. Either it will be altered in some way, or it will be sold in its current state.
In order for something to be listed in the inventory:
- You must have purchased it, correct?
When you sell something on consignment, the item is still legally considered to be the property of the original manufacturer or supplier. That is not part of your inventory; it belongs to the other party.
- It must be available for purchase.
Items that you have purchased to assist in the operation of your company, such as stationery or work tools, are not considered inventory.
Inventory consists solely of the items that are retained by your client. Not included are the tools that you will use along the route.
Why is inventory necessary?
You may simply place an order for what you require, at the precise time that you require it.
In addition, some companies are able to successfully run using a system similar to this just-in-time model. However, it is impossible for the majority of businesses to organize their supply chains in such a precise manner.
How do I handle inventory?
If your company maintains an inventory – and the vast majority of them do – there are a few things that you are going to be responsible for doing:
- Notify the appropriate parties – as your inventory is a factor in determining the worth of your company, it is required to be disclosed on your tax returns, in business valuations, and in insurance policies.
- Take good care of it; your company’s inventory has the potential to generate profits as well as losses, so you need to give some consideration to the ordering and storing of stock, as well as the timing of those decisions.
- Always stay on top of the metrics, because in order to accurately report and manage your inventory, you need to be aware of both its cost and its value. Inventory accounting is where you’ll find its application here.
There is no need for this to be as challenging as it appears.
There are shortcuts in accounting that might make things simpler for companies that are just starting out. As your business expands, you will find a need for various time-consuming tasks and number crunching that may be handled by software and mobile apps.
Chapter 2: Inventory classifications
Have you got stock? If you have an understanding of the many categories of inventory, you will be better able to identify it for purposes of management and valuation.
The inventory can be found in a variety of configurations, states, and phases.
If you have a good understanding of the types, you will have an easier time valuing and managing it. Let’s take a look at each of them.
The shelves of most retail establishments contain products, and the rear rooms often contain even more. All of the inventory has been stated.
Installing products in the form of a service
There are many different kinds of service firms, and most of them sell items in addition to their labor.
As one illustration, a mechanic’s work duties often include the sale of various components, such as gaskets.
A fee is typically charged by a gardener for the application of fertilizers.
It’s possible for a hairdresser to stock and sell several hair products. Products such as these are also considered inventory.
What you’re producing (manufacturing)
There are three different kinds of inventory that manufacturers deal with. They can be broken down into these categories: raw materials (which have not yet been worked on), work in progress (which is still being done), and final goods (which are ready for shipping).
There are numerous inventory options you can have
You might decide to sell some things precisely as you bought them, while changing others in some way before selling them. In this scenario, you are in possession of both finished goods and raw materials. It is much simpler than you may imagine to lose track of inventories.
Your ability to recognize everything can be improved by considering these three categories.
There are four possible locations for the inventory that you own:
- On the shelf, it can be out for inspection and all set to be purchased.
- It could be in the back of a shop, in a warehouse, or even in a work truck if it is now in storage.
- It is possible that it is being transported in a car between the seller and the purchaser.
- On consignment – In the store of a third party, where it is being held for potential customers to purchase it (some shops will only buy a product from a manufacturer or supplier once they’ve sold it themselves).
Your ability to run a successful business will be enhanced if you are aware of the location of all of your inventory as well as the inventory that you now have.
You will have a better understanding of where your money is invested, and you will have the ability to make decisions that will safeguard that capital. Your next objective should be to improve how you keep track of inventory.
Chapter 3: Management of inventory
Learning how to manage your inventory will help your business run more efficiently and generate more revenue.
Your company will function more efficiently and generate more revenue if you have a comprehensive perspective of your inventory; the question is, where should you begin?
What is management of inventory?
Managing inventories includes doing things like:
- keeping track of items, including where they are and how long you’ve had them
- being aware of their worth, including how much they cost and how much they’re selling for, and being able to accurately estimate demand are all important aspects of inventory management
- gaining an understanding of what customers want and then ordering accordingly
Why is inventory control so important?
Keeping fewer items in stock for a shorter period of time is one of the primary objectives of inventory management. This results in less stock being handled, fewer losses incurred as a result of damage or spoilage, and a lower danger of products becoming obsolete.
You will also find out which product lines are bringing in the most clients (having the highest sales), as opposed to those that generate the most income, as opposed to those that give the best profits. That is very helpful information to have.
How to begin inventory optimisation
You are aware of the value of your inventory, and you wish to manage it in the most effective manner possible. So what do you do?
There is a lot to learn about optimising inventory, and it could include a lot of arithmetic, but you don’t have to dive headfirst into the subject right away. Here are three things you can do right this second to start heading in the right direction.
1. Begin by performing an ABC analysis
When it comes to the company’s bottom line, not all inventory is created equal. It’s common for a very small number of products to account for the majority of a company’s revenues and profits.
The 80/20 rule is a common name for this principle. Your inventory is divided into these three broad categories in order to do an ABC analysis:
- The very few goods that generate the majority of your revenue.
- The performers who do an adequate job and bring in a respectable amount of money
- The vast majority of products that do not generate a lot of revenue (often as a result of low sales or prices).
You need to pay extra close attention to your A inventory because making mistakes in that area might result in significant financial losses. The things denoted with a C need less of your focus. You will gain a framework for prioritizing your focus and energy with the help of this activity.
2. Recognise demand and forecasts
The foundation of effective inventory management is the ability to generate reliable forecasts of future requirements. When beginning a business for the first time, it may feel like a game of guess and check (see our tutorial on how to construct your first sales predictions), but it doesn’t have to be that way.
You can determine what’s popular and what’s not by looking at your sales statistics. In order to see trends over time, it is helpful to segment reports of sales activity into daily, monthly, and quarterly summaries.
Put your orders in accordance with that principle as a reference.
You are free to factor in additional aspects such as promotions, the state of the economy, upcoming holidays, and so on; but, prior experience should serve as your foundation.
3. Take into account lead times
It is not always possible to pick up the phone and place an order for additional inventory for the next day. Find out how it can be done.
How about the price of the things sold?
It takes a significant amount of time to restock certain supplies and account for this fact while managing your inventory. It’s a straightforward action, yet taking it can prevent you from repeating the same errors over and over again.
Chapter 4: Accounting for inventory
When it comes to making accurate tax reports and running a profitable firm, inventory accounting is an absolutely necessary function.
It is important to keep track of your inventory statistics because they may be both a substantial expense and a significant source of revenue.
In addition to that, you are required to include a report of it on your tax return. Now, let’s take a look at the fundamentals of accounting for inventories.
Accounting for inventory entails what exactly?
Accounting for inventory enables one to ascertain how much of it is currently in stock, how much it currently costs, and how much it is currently worth to the company. It will assist you in determining whether or not the performance of your company is as good as it could be.
How to account for inventory
When you make a purchase of an item for your stock, the transaction is recorded in your books as both a cost and an asset. Because you have the ability to sell it, it is considered an asset.
After you have sold the item, you will need to include it in your income. Additionally, it is removed from the inventory of your assets.
You can also account for your inventory using other methods besides this one. It’s possible that other approaches would work better for your company.
You can also choose to register your inventory as an asset when you buy it, and then wait to record the cost of the inventory (along with the income) until it is sold. This is one approach.
It’s straightforward, but there’s a catch
When prices are often fluctuating, it might be difficult to keep track of how much you have spent on various items. Accountants have two different options available to them to circumvent this.
1. Cost-weighted average technique (AVCO)
You need only use the average cost per item when calculating prices for each product line.
A preliminary estimate of the worth of your inventory can be calculated by multiplying this item’s average cost by the total number of items in your possession.
AVCO is a simple method, but it does not take into account all of the relevant information, and it does not perform very well when there are big price shifts.
2. Method of “first in, first out” (FIFO)
Using the FIFO accounting method, you are able to place a unique monetary value on each item in your stock.
You are working on the assumption that you sell your oldest products first, even if in reality this could not be the case. Using FIFO will provide you with a more comprehensive analysis of the worth of the inventory that is currently on hand. In addition to this, you will have a clearer understanding of your profit margin and how it shifts over time.
It is absolutely necessary to be aware of the worth of the inventory that is currently being held in stock. However, it is also vitally important to be aware of the worth of the inventory that has been sold. You will be better able to obtain an idea of how much money the company is making with the use of that information.
The cost of goods sold, often known as COGS, is what determines this amount.
Cost of Goods Sold (COGS) = Beginning Inventory Plus Purchases Minus Ending Inventory
Using this technique, you may determine how much inventory you had to purchase in order to get the revenue that you did.
The majority of companies utilize this straightforward COGS calculation for accounting their inventory.
When it comes to calculating your profit, you have the ability to get into further specifics by including in things like the costs of storage and handling.
Check out our guide on starting a business for more information on COGS.
What is stocktaking, exactly?
The purpose of stocktaking is to verify the accuracy of the figures found in your financial records. You can accomplish this by counting each individual item of inventory that you have in your possession.
Make a comparison between that number and what is shown on your balance sheet. They rarely coincide with one another. In most cases, there will be less in actuality compared to what is written down.
In most cases, one will presume that the missing inventory was either stolen or corrupted before being dumped.
Why is stocktaking so important?
Before you hand in your tax return for your company, you could be asked to carry out a stocktake first. In addition to that, it is a very helpful method for checking and adjusting the data related to your finances.
How frequently should I conduct a stocktake?
At the end of the fiscal year, the tax authorities may compel you to do a stocktake of your assets. Some companies do it significantly more frequently than that. Take, for instance:
- retail shops may do it quarterly (if they sell seasonal goods)
- it’s common practice for organizations in the hospitality industry to do it once a month
- although manufacturers of perishable items might do it even more regularly.
If the results of a physical stocktake are very similar to the results recorded in your financial records, you may be able to postpone your next stocktake for a longer period of time.
This level of accuracy can occasionally be delivered by computerised inventory management systems.
They keep track of the stock automatically when you place orders and deduct it from the total when the items are sold.
You can supplement this technology with cycle counts, which include conducting a physical count of a few product lines at random to validate that your book entries are accurate representations of the current situation.
Chapter 5: Inventory control systems
Different types of businesses require uniquely tailored approaches to inventory management. Which of these choices is going to be most beneficial to your company?
You are already aware of how important inventory management is to the success of a firm.
Now that we have that out of the way, let’s take a look at some of the efficient methods of costing, reporting, and reordering inventory you can employ.
System of periodic inventory
A periodic inventory system is the most fundamental inventory method, and it is the one that is most commonly employed by smaller firms. It requires conducting regular stocktakes, which are just physical counts of your goods, at predetermined intervals.
You compare those statistics to the entries in your books pertaining to the sales and purchases you’ve made.
In the chapter on inventory accounting titled “Stocktaking,” you can find further information about taking inventory.
System of perpetual inventory
In the case of a perpetual inventory system, the records are brought up to date whenever an item of inventory is bought or sold.
Typically, software is responsible for carrying out this task. Because you use the system to place your orders, it is aware of everything that you have requested. In addition to this, you connect it to your point-of-sale (or invoicing) systems so that it is aware of the items that have been sold.
Because it does all of the calculations necessary for AVCO or FIFO accounting in real time, you will be able to determine how much profit each sale brings in.
You will still be required to conduct periodic stocktakes to ensure that the system is functioning appropriately, in addition to submitting annual tax reports.
Which inventory management system is best for you?
For companies that only offer a small number of products, it’s possible that managing their inventory on a periodic basis will be sufficient. It will give you a general idea of how much money your business spends on its inventory and will enable you to finish your annual accounting.
However, if the scope of your products, the volume of your sales, or the number of your locations expand, periodic inventory management will start to become a bottleneck for your operations. In addition, you will have a tough time carrying out the more accurate FIFO accounting.
You will be able to see your margin in real time with a perpetual inventory management system, which will also free up a significant amount of the time that you would have otherwise spent on stocktakes.
Chapter 6: Inventory control software
The use of inventory management software alleviates many of the challenges that small firms face while managing their inventory. Before you go ahead and get one, there are a few things you should think about first.
The time saved by using inventory management software may provide you the opportunity to take stock in a different sense. For example, you may have more time to spend with your loved ones or to formulate a strategy for taking things to the next level.
What is the purpose of inventory software?
The most fundamental function of inventory software is to track your orders and sales in order to calculate your stock levels. Another name for this kind of inventory management is the perpetual inventory system.
When functioning properly, these systems are able to:
- display the current levels of your inventory at any moment;
- reorder stock for you;
- display the amount of revenue generated by each individual product for your company.
What is the operation of inventory management software?
The process by which inventory software works is to register new items of stock as soon as they are received. This can be done manually through data entry or automatically by a system such as:
- SKU numbers (stock keeping unit)
- serial numbers
- barcode scanning
- RFID (radio frequency identification) tags
- QR (quick response) codes
- NFC tags, which stand for “near field communication,”
The software that you use for invoicing or point-of-sale (POS) detects the item the moment it is shipped out or sold, and it quickly adjusts the records of inventory to reflect the change to account for the new information. One example of an inventory management system is the scanner that is utilised at the check-out counter of a supermarket.
Once it has established what inventory you do or do not have, the programme is able to execute a range of additional jobs based on the features that it contains because it is capable of doing so. These tasks include:
Inventory management software features to search for
There is a good chance that you will be able to use your accounting software to manage your inventory because many packages come with the capability of managing inventory already built in.
Therefore, you should consider what you actually need and verify if your accounting software can perform the following before spending money on an item of inventory management software with plenty of bells and whistles:
- offer you data in real time
- help you place purchases more easily by alerting you when supplies are running low
- all of the procedures, including pricing, ordering, billing, and delivery, should be automated and integrated
- integrate point-of-sale software
- control several locations remotely
- scan barcodes, QR codes or read RFIDs
- forecast seasonal demand
- control lots, keep an eye on expiration dates, and manage batches
- take care of refunds and exchanges
- whenever necessary, attach vendor contracts and photographs
- integrate with the software used for eCommerce
- scale up as your company grows
- stocktaking functionality
Hillyer Riches are qualified accountants and business advisors who can take care of all your accounting and business advisory needs, so you can focus on what you’re good at – running your business.
Contact us today at (03) 9571 5333 or firstname.lastname@example.org for a consultation!
Inventory is the raison d’être of your company, and one of the most significant purchases you will make as a business owner. If done in the right way and with the appropriate tools, managing an inventory can be a breeze.
As your business expands, you will find a need for various time-consuming tasks and number crunching that may be handled by software and mobile apps. Inventory can be found in a variety of configurations, states, and phases. There are shortcuts in accounting that might make things simpler for companies that are just starting out.
Learning how to manage your inventory will help your business run more efficiently and generate more revenue. There are four possible locations for the inventory that you own – it could be on the shelf, in the back of a shop, in a warehouse or even in a work truck.
You will find out which product lines are bringing in the most clients (having the highest sales), as opposed to those that generate the most income. You will gain a framework for prioritizing your focus and energy with the help of this activity. The foundation of effective inventory management is the ability to generate reliable forecasts of future requirements.
Accounting for inventory enables one to ascertain how much of it is currently in stock and how much it costs. It will assist you in determining whether or not the performance of your company is as good as it could be. Find out how it can be done. Accountants have two options available to them to circumvent this problem. Using the “first in, first out” method, you are able to place a unique monetary value on each item.
Using FIFO will provide you with a more comprehensive analysis of the worth of the inventory that is currently on hand. The purpose of stocktaking is to verify the accuracy of the figures found in your financial records.
Using this technique, you may determine how much inventory you had to purchase in order to get the revenue you did. The majority of companies utilize this straightforward COGS calculation for accounting their inventory. Different types of businesses require uniquely tailored approaches to inventory management.
Which of these choices is most beneficial to your company? Take a look at some of the more efficient methods of costing, reporting, and reordering inventory you can employ.
For companies that only offer a small number of products, managing inventory on a periodic basis may be sufficient. You will be able to see your margin in real time with a perpetual inventory management system. The most fundamental function of inventory software is to track your orders and sales.
This can be done manually through data entry or automatically by a system such as RFID tags. When an item is sent or sold, the software that you use for invoicing or point-of-sale (POS) detects the item and immediately modifies the records of inventory. There is a good chance that you will be able to use your accounting software to manage your inventory.