In its simplest form, inventory includes all of the items that a business uses for production or sale to an end user – it’s instrumental for businesses to be able to earn a profit.
Inventory is one of these easy and hidden ways to lose money. The detail around inventory is important. The 12 types of inventory you need to know as retail, wholesale or manufacturing business are outlined for your reference and opportunity to ensure you have a system in place to track and maximise your profit.
Whether you own a wholesale, retail or manufacturing business, you have inventory. Inventory is fundamental to any business but especially, inventory based businesses. In fact, almost any business has inventory to some extent and they must find an effective way to manage it.
Inventory is the component stock on hand to manufacture the goods you sell or it’s the goods themselves. Inventory control includes the methods used to manage the inventory you have in stock. This includes everything from how many items you have on shelves to how much the stock and components cost and the amount of time it takes to refill your stock on hand.
The end user that is sold the inventory can be a business or individual. In the case of a manufacturer or wholesaler, the end user is another business. These business types operate business-to-business (B2B) business models. A product seller operates a business-to-consumer (B2C) business model. Either way, these business structures have inventory; therefore, there needs to be a way to manage that inventory that is efficient and cost effective.
Businesses that are efficient and profitable have tight inventory management so they don’t hold too much of their money in their stock. It’s a delicate balance as they also need to plan to not go out of stock. This is also an issue because if you don’t have stock to sell you will lose sales.
Inventory makes money for your business when it sells and it costs money when it’s sitting on the shelves not moving.
In accounting terms, inventory is considered an asset. When inventory turns over (is sold), it represents one of the primary sources of revenue generation. Having just the right amount of inventory is the key to generating earnings for your business and your shareholders.
Different inventory types
There are three primary types of inventory: raw materials, work-in-progress, and finished goods. Regardless of the size business you have it’s important to track your inventory as it moves throughout your business at different stages of being used and/ or sold. Here is the detail of expanding these three primary types of inventory to include all twelve types of inventory and how they may apply to your business.
1. Raw materials
Raw materials are items used to manufacture a finished product or the individual component parts that collectively make up the finished product. Raw materials can be produced in-house, or they can be secured from a vendor. As an example, a chocolate manufacturer needs cocoa beans (raw material) to make a finished product. The manufacturer can grow the beans or source them from a supplier.
If you are outsourcing raw materials, timely arrival from suppliers is necessary to ensure smooth manufacturing operations. However, that is delicately balanced with quality. Just as you cannot build a house on a poor foundation, you cannot create a quality finished product with inferior raw materials. Sourcing, ordering and tracking raw materials is an important step to ensure your business has a strong foundation.
2. Work in progress (WIP) inventory
The work-in-progress inventory refers to the components in use to make the finished product; however, the product is not entirely ready for sale. In simple terms, WIP is the partially completed product. For example, WIP inventory might be the components not yet assembled.
WIP inventory cannot be sold until it’s finished. Nonetheless, it occupies space in your warehouse; therefore, costs money. Too much WIP inventory is a big overhead and can be bad for business – as a compounding effect, WIP inventory can raise storage costs without securing revenue. This can quickly become a nightmare especially if you are missing components to create finished products.
Some business models require upfront payment or a deposit prior to manufacturing a product. In those instances, the WIP inventory has already generated revenue. This is common for custom-made orders. For example, beds are often manufactured once sold. In this instance, it can take longer for the customer to receive the final product, but it costs less for the business, and those savings can be passed to the consumer.
3. Finished goods
These are the goods that have been completed by the manufacturing process or purchased in a completed form. Finished goods have yet to be sold to the customer – whether that is a business or consumer. Like raw materials, finished goods can be entirely manufactured by the business or outsourced from a supplier.
Finished goods is the stock inventory available for customers to purchase. Most businesses prioritise finished goods.
4. Decoupling stock
This process is the separating of inventory within the manufacturing process to reduce risk of one stage of the manufacturing process from slowing down another stage. Manufacturers set aside extra raw materials or WIP for some or all stages in the production line. In the event of low stock, delays in the supply chain, or a breakdown in one stage, production doesn’t stop further down the line. The finished product can still be manufactured.
5. Maintenance, repair, and operations (MRO) goods
The MRO goods are elements needed in the manufacturing and finished goods creation process but are not part of the final product. Examples include:
PPE and employee uniforms
MRO goods are either absorbed or discarded within the production process.
Another example of MRO goods are laptops and a WiFi connection. Unless you are in the business of selling laptops, your computer doesn’t directly bring in revenue. But if you’re a content marketer, your computer is used for writing, video editing, and designing – it is the machine that generates revenue and is an important part of the process.
It’s essentially important to maintain MRO inventory to avoid negative impacts to the quality of your final products. Not managing MRO effectively can also increase the risk of spoilage during the production process leading to losses.
It's important to consider the efficient management of MRO as it can also reduce profitability. E.g. breaking a laptop and needing it replaced.
6. Packing and packaging materials
Packaging is an integral part of the fulfilment process. As products are ready to sell, they need to be protected in transit, and packaging protects them. Damage in transit can negatively impact the customer experience, leading to order returns.
Whilst it can be easy to blame the courier for not handling the product properly, it’s also important to ensure that the packaging materials are adequate. Packing involves protecting finished goods using wrapping such as bubble wrap or other wrapping. The goal of packing is to protect the product from damage.
Packaging is a box or outer wrapper designed to identify the brand.
Packaging is also brand identification. Another expectation associated with packaging is to identify the contents – whether with hazardous material labelling or fragile contents labelling. Appropriate labelling ensures the product will not be mishandled or opened in such a way as to destroy or damage the contents. All these packaging elements are individual costs and another type of inventory to have on hand so that products can be appropriately shipped to customers when ordered.
7. Safety stock
Safety stock is another term used to describe extra stock or inventory on hand to meet the needs of customers should there be a glitch in the supply chain. This form of inventory is to be held as a buffer and should be just enough to meet demand while waiting for supply to arrive. It’s a delicate balance between increased storage costs and dissatisfied customers.
8. Cycle inventory
Cycle stock is also referred to as working inventory. The amount of inventory that needs to be kept to meet the steady demand during a specific period. The amount of cycle stock is determined based on historical data and forecasts. Planning is important to be able to allocate this. Cycle stock is used to fulfil sales orders; thus, it needs to be regularly replenished to meet demand – it’s cycled.
Cycle stock is used to fulfil expected demand, alternatively safety stock is used when cycle stock fails to meet that demand, or has yet to be replenished.
9. Service inventory
This inventory type applies to the service industry. Service inventory refers to the internal processes that allow an organisation to rapidly respond to customer demands. For example, an airline makes money selling seats. If a seat remains empty, the flight loses money – it loses inventory. A set of usually automated internal processes, such as discounts and last minute specials affect whether that seat is sold.
Another example is a hotel. A hotel with 100 rooms has a monthly inventory of 300 stays (assuming a 30-day month). Restaurant inventory is the number of tables and bookings per hour over the time period the restaurant is open. Hotels and restaurants also usually have processes in place to sell inventory at a discounted rate.
Other examples of service industry include advertising, healthcare, health clubs, and cloud computing. Any service business that sells “space” – that “space” is service inventory whether it is cloud space or a seat on a plane.
10. Pipeline or transit inventory
After products leave the warehouse, they become pipeline, or transit, inventory. This inventory type refers to what is moving between manufacturer, distributor, and retail outlet.
Pipeline inventory is somewhere in the shipping chain and has yet to reach its intended destination.
11. Obsolete stock
Obsolete or expired stock is excessive inventory. It is a liability for the company. It is not selling, so it costs the business money in terms of storage cost.
12. Seasonal inventory
Inventory specifically ordered or created to fulfil a surge in demand that is specific to an event, like Christmas, is known as seasonal inventory. Seasonal inventory is also called anticipation inventory. An example is retailers must anticipate a spike in demand around holidays and forecast the products likely to draw shoppers. Mismanagement of this will cost the business money in terms of lost opportunity, storage, or discounts
Managing your inventory
Understanding and effectively managing the various types of inventory is not just a task—it's an imperative for the health and success of your business. An inefficient inventory system can lead to operational hiccups, financial loss, and missed opportunities. In contrast, a robust inventory management system can streamline your operations, improve customer satisfaction, and ultimately drive your business growth. It's not merely about knowing how much stock you have; it's about optimizing this valuable asset to propel your business forward. At SMB Consultants, we specialize in creating tailored inventory management solutions that perfectly suit your business needs. Don't let inventory issues hold you back—reach out to us to revolutionize how you manage your inventory, and watch your business thrive.