What Is Inventory?

What Is Inventory?


In financial jargon, inventory is defined as the sum of the value of raw materials, fuels and lubricants, spare parts, maintenance consumables, semi-processed materials and finished goods stock at any given point of time. The operational definition of inventory would be: the amount of raw materials, fuel and lubricants, spare parts and semi-processed material to be stocked for the smooth running of the plant. Since these resources are idle when kept in stores, inventory is defined as an idle resource of any kind having an economic value.

Inventories are maintained basically for the operational smoothness, which they can affect by parting successive stages of production, whereas the monetary value of inventory serves as a guide to indicate the size of the investment made to achieve this operational convenience. The materials management department is expected to provide this operational convenience with a minimum possible investment in inventories. The objectives of inventory, operational and financial, needless to say, are conflicting. The materials department is accused of both stock outs as well as large investment in inventories. The solution lies in exercising a selective inventory control and application of inventory control techniques.


Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business. Inventory are held in order to manage and hide from the customer the fact that manufacture/supply delay is longer than delivery delay, and also to ease the effect of imperfections in the manufacturing process that lower production efficiencies if production capacity stands idle for lack of materials.

The reasons for keeping stock

All these stock reasons can apply to any owner or product stage.

Buffer stock is held in individual workstations against the possibility that the upstream workstation may be a little delayed in providing the next item for processing. Whilst some processes carry very large buffer stocks, Toyota moved to one (or a few items) and has now moved to eliminate this stock type.

Safety stock is held against process or machine failure in the hope/belief that the failure can be repaired before the stock runs out. This type of stock can be eliminated by programmes like Total Productive Maintenance

Overproduction is held because the forecast and the actual sales did not match. Making to order and JIT eliminates this stock type.

Lot delay stock is held because a part of the process is designed to work on a batch basis whilst only processing items individually. Therefore each item of the lot must wait for the whole lot to be processed before moving to the next workstation. This can be eliminated by single piece working or a lot size of one.

Demand fluctuation stock is held where production capacity is unable to flex with demand. Therefore a stock is built in times of lower utilisation to be supplied to customers when demand exceeds production capacity. This can be eliminated by increasing the flexibility and capacity of a production line or reduced by moving to item level load balancing.

Line balance stock is held because different sub-processes in a line work at different rates. Therefore stock will accumulate after a fast sub-process or before a large lot size sub-process. Line balancing will eliminate this stock type.

Changeover stock is held after a sub-process that has a long setup or change-over time. This stock is then used while that change-over is happening. This stock can be eliminated by tools like SMED.

Where these stocks contain the same or similar items it is often the work practice to hold all these stocks mixed together before or after the sub-process to which they relate. This 'reduces' costs. Because they are mixed-up together there is no visual reminder to operators of the adjacent sub-processes or line management of the stock which is due to a particular cause and should be a particular individual's responsibility with inevitable consequences. Some plants have centralized stock holding across sub-processes which makes the situation even more acute.

Inventory terminology

Inventory or stock is referred to in a variety of ways:

(1)A Stock-keeping unit (SKU) is a separately identifiable class of item, which is complete in the sense that a customer in that form can utilize it.

(2)Manufacturing, wholesale and retail inventory depends on the type of firm holding the inventory. These could be held in different forms for the same material. For example, wholesale in bulk form, and retail in packaged form.

(3)During manufacturing, input inventory is raw material; an inventory in-between processing stage is referred to as work-in-process; and after the completion of manufacturing is called as finished goods inventory.

(4)Transit or in-transit or pipeline inventory is inventory that either waiting or in the process of transportation. The speed of transportation and the point of time of ownership transfer of pipeline inventory determines the time of holding, and hence the cost of holding this inventory.

(5)Seasonal stock refers to the material, which is purchased or manufactured in anticipation of seasonal demand.

(6)Promotional stock is the additional stock kept ready for the increase in demand due to market promotions of products.

(7)Speculative stock is the additional stock purchased as a hedge against the possibility of future increase in price of the material.

(8)Dead stock is unused and / or obsolete stock, which cannot be sold.

Functions of Inventory

The necessity of holding inventory is due to the following functions of inventory:


A firm can either produce all the required variety products at a plant at one location, or, produce different products at separate plant locations. Locating separately will enable the firm to select the location of each different product manufacturing plant based on the particular requirements of that product, thus achieving specialization efficiencies like geographical facilities and economies of scale. This specialization approach creates inventory at diverse locations. Also, pipeline inventories are created due to transport linkages required between different manufacturing plants and with distribution warehouses.

(2)Balancing supply and demand:

Demand depends upon the requirements of customers relating to time and quantity of products, and is not in the control of the producer. Supply, on the other hand is under the producer’s control, but has to be economized and also paced with the time and quantity requirements of customer demand. In order to ensure that customers are not dissatisfied when they demand the required quantity of products, it is necessary to have adequate inventory of products available at all times. This is the balancing inventory required due to the different rates of manufacturing and consumption. In case of seasonal products when production has to take place for a longer period of time in advance of the season, production throughout the year ensures lower investments in production capacities while increasing inventory. An example is the production of rainwear throughout the year for the sales which will occur only during the rainy season. Another example of balancing is seasonal production during raw material availability and year-round consumption, which also requires inventory. The example of this is seasonal availability of mango fruit and year-round consumption of mango –based products.

(3)Economies of scale:

Economies of scale are obtained by holding large inventories:(a) While purchasing, ordering in large quantities provides cost economies and discounts; (b) transportation economies are obtained by transporting in larger quantities; and, (c) during manufacturing, producing in economic batch quantities lower costs.

(4) Overcoming uncertainty:

Safety stock of inventory is required to overcome uncertainty of customer demand on the one hand; and, purchasing, receiving, manufacturing, and order processing delays on the other. Either of these may result in shortages of products at the time of customer requirements if adequate safety stock of material is not provided for. If such material stock outs are not frequent occurrences, the customer may look elsewhere leading to a last order at the very least, or a lost customer. This uncertainty results in buffer stocks being created between (a) supplier and purchasing, (b) purchasing and production, (c) production and marketing, (d) marketing and distribution, (e) distribution and intermediary, (f) intermediary and customer, in order to avoid stock outs.


The most important objective or inventory control is to determine and maintain an optimum level of investment in the inventory. Most companies have now successfully installed one or the other system of inventory planning and control.

Inventory Management and Inventory Control must be designed to meet the dictates of the marketplace and support the company's strategic plan. The many changes in market demand, new opportunities due to worldwide marketing, global sourcing of materials, and new manufacturing technology, means many companies need to change their Inventory Management approach and change the process for Inventory Control.

Despite the many changes that companies go through, the basic principles of Inventory Management and Inventory Control remain the same. Some of the new approaches and techniques are wrapped in new terminology, but the underlying principles for accomplishing good Inventory Management and Inventory activities have not changed.

The Inventory Management system and the Inventory Control Process provides information to efficiently manage the flow of materials, effectively utilize people and equipment, coordinate internal activities, and communicate with customers. Inventory Management and the activities of Inventory Control do not make decisions or manage operations; they provide the information to Managers who make more accurate and timely decisions to manage their operations.


Inventory management refers to the process of managing the stocks of finished products, semi-finished products and raw materials by a firm. Inventory management, if done properly, can bring down costs and increase the revenue of a firm.

How much one should invest in inventory management? The answer to this question depends on the volume and value of inventory as a percentage of the total assets of a firm. The importance of inventory management varies according to industries. For example, an automobile dealer has very high inventories, sometimes as high as 50 per cent of the total assets, whereas in the hotel industry it may be as low as 2 to 5 per cent.

The process of inventory management is a continuous one and there are various kinds of solutions available. It is advisable to employ specialized staff for inventory management.

The inventory management process begins as soon as one has started production and ordered raw materials, semi-finished products or any other thing from a supplier. If you are a retailer, then this process begins as soon you have placed your first order with the wholesaler.

Once orders have been placed, there is generally a short period of time available to a firm to put an inventory management plan in place before the supplies are delivered. Inventory management helps a firm to decide in advance where these supplies should be stored. If a firm is getting provisions of small-sized goods, it may not be much of a problem to store them, but in the case of large goods, one has to be careful so that the warehousing space is optimally utilized.

From invoices to purchase orders, there is lot of paperwork and documentation involved in inventory management. Several software programs are available in market, which help in inventory management.

Inventory Management provides detailed information on Inventory Management, Inventory Management Software, Supply Chain Inventory Management, Inventory Management Systems and more. Inventory Management is affiliated with E-Procurement Services.


1. Raw materials Inventory:

This consists of basic materials that have not yet been committed to production in a manufacturing firm. Raw materials that are purchased from firms to be used in the firm's production operations range from iron ore waiting processing into steel to electronic components to be incorporated into stereo amplifiers. The purpose of maintaining raw material inventory is to uncouple the production function from the purchasing function so that delays in shipment of raw materials do not cause production delays.

2.Stores and Spares:

This category includes those products, which are accessories to the main products produced for the purpose of sale. Examples of stores and spares items are bolts, nuts, clamps, screws etc. These spare parts are usually bought from outside or some times they are manufactured in the company also.

3.Work-in-Process Inventory:

This category includes those materials that have been committed to the production process but have not been completed. The more complex and lengthy the production process, the larger will be the investment in work-in-process inventory. Its purpose is to uncouple the various operations in the production process so that machine failures and work stoppages in one operation will not affect the other operations.

4.Finished Goods Inventory:

These are completed products awaiting sale. The purpose of finished goods inventory is to uncouple the productions and sales functions so that it no longer is necessary to produce the goods before a sale can occur.

5. Production inventories:

They represent raw materials, parts and components that are used in the process of production. Production inventories include

  • Standard industrial items purchased from outside (also called bought outs)
  • Non-standard items (purchased items)
  • Special items manufactured in the factory itself (also called works made parts or piece parts.

6. MRO inventories:

They refer to the maintenance; repairs and operation supplies, which are consumed during process of, manufacture but do not become a part of the product.

7.In-process inventories:

They represent items in the semi-finished condition (i.e. items in the partially completed stage)

8. Goods-In-Transit:

They represent such materials, which have been paid for but have not yet been received by the stores.

The reasons for keeping inventory

There are three basic reasons for keeping an inventory:

  1. Time - The time lags present in the supply chain, from supplier to user at every stage, requires that you maintain certain amount of inventory to use in this “lead time”
  2. Uncertainty- Inventories are maintained as buffers to meet uncertainties in demand, supply and movements of goods.
  3. Economies of scale - Ideal condition of "one unit at a time at a place where user needs it, when he needs it" principle tends to incur lots of costs in terms of logistics. So Bulk buying, movement and storing brings in economies of scale, thus inventory.

Manufacturing organizations usually divide their "goods for sale" inventory into:

  • Raw materials- materials and components scheduled for use in making a product.
  • Work in process, WIP - materials and components that have begun their transformation to finished goods.
  • Finished goods - goods ready for sale to customers.
  • Goods for resale - returned goods that are salable.
  • Spare parts

The logistics chain includes the owners (wholesalers and retailers), manufacturer’s agents, and transportation channels that an item passes through between initial manufacture and final purchase by a consumer. At each stage, goods belong (as assets) to the seller until the buyer accepts them. Distribution includes four components:

Manufacturer’s agent’s




  1. Manufacturer’s agent’s: Distributors who hold and transport a consignment of finished goods for manufacturers without ever owning it. Accountants refer to manufacturer’s agent’s inventory as "material" in order to differentiate it from goods for sale.
  1. Transportation: The movement of goods between owners, or between locations of a given owner. The seller owns goods in transit until the buyer accepts them. Sellers or buyers may transport goods but most transportation providers act as the agent of the owner of the goods.
  1. Wholesaling: Distributors who buy goods from manufacturers and other suppliers (farmers, fishermen, etc.) for re-sale work in the wholesale industry. A wholesaler's inventory consists of all the products in its warehouse that it has purchased from manufacturers or other suppliers. A produce-wholesaler (or distributor) may buy from distributors in other parts of the world or from local farmers. Food distributors wish to sell their inventory to grocery stores, other distributors, or possibly to consumers.
  1. Retailing: A retailer's inventory of goods for sale consists of all the products on its shelves that it has purchased from manufacturers or wholesalers. The store attempts to sell its inventory (soup, bolts, sweaters, or other goods) to consumers.


These response based techniques are all variations on a theme that concentrates on rapidly replenishing forward inventories according to sales experience.

To accommodate the “independent” nature of customer demand, world class logistics organization is perfecting time based strategies. Major retailer such as wal-mart has been a leader in the application of these systems. The objective of time based strategies is to reduce inventory for the total supply chain.

Quick response: quick response is a co-operative effort between retailers and suppliers to improve inventory rapidity .QR is implemented by monitoring retail sales for specific product and sharing information across the supply chain to guarantee that the right product assortment will be available when and where it is required. As orders from retailers it facilitates information sharing between retailer and manufacturers.

A retailer places an order for replenishment; the supplier with the help of EDI [Electronic data interchange] finalizes the delivery details and communicates them to the customer in advance. This facilitates scheduling labor and other facilities. This reduces inventories as uncertainties are reduced and total cost resulting into better performance.