Inventory Management: Types, Functions, Nature and Auditing

Introduction on Inventory Management

For any manufacturing company, raw material is one of the key inputs. As we know that raw material is the one on which you have not yet added any value so far except bringing it to the production facility. Here you need to understand that your supplier’s finished goods are your raw materials.

Raw material is composed of two elements. One is materials and the other is components. For materials the form, fit and function will drastically change during the production process. But the components doesn’t undergo much change.

How to differentiate between material and components. Many companies use the 80-20 rule. In case of components the form, fit and function will not exceed 20% and the rest are all materials. Again materials and components put together form raw materials.

The moment any value addition is performed on the raw materials, it becomes the work-in-process. As more and more value additions are performed, the value of the work-in-process continue to increase. These value additions are continued until the work-in-process reaches the stage of finished goods.

So, a work-in-process almost at the end of the manufacturing process is more valuable than the one at the beginning. Here the term value addition refers to the manufacturing processes that transforms the raw materials into finished goods.

The terms work-in-process or work-in-progress are one and the same. It is shortly known as whip .. W I P.

Finished goods is the mission of an organisation. This is the very purpose of establishing an organisation. The finished goods are sold to the customers and the company earns a profit.

When all the value additions are completed, and quality is ensured the product is ready for sale. This also includes inspection, testing, documentation, packaging etc.

A company may produce wide variety of products to appeal to its customers. So, the finished goods are identified with model or SKU number. SKU is the acronym of Stock Keeping Unit.

Once the finished goods are ready, they are stored in the warehouse attached to the factory, known as FG Warehouse. From there it is shipped to the various warehouses across the country or the globe through roadways, railways, airways and ocean carriers.

The moment finished goods crosses the dock of the FG Warehouse; it becomes part of the distribution system. It continues to be part of the distribution system until it is sold to the end consumers like you and me.

So, all finished goods that are part of the distribution system is called as distribution inventory. This includes those finished goods that are under transportation and that are stored in various warehouses across a geography.

There are two types of distribution inventory. One, is company owned and the other is distributor owned. These terms are self-explanatory. Basically, it says who owns the distribution inventory.

A company carefully watches the distribution inventory and tries to keep it between a min-max level for any given region. The distribution inventory is one of the factors that influences your production forecast.

The raw material, work-in-process, finished goods and distribution inventory are well connected. This represents a value chain. Value is continuously added from raw material until it becomes finished goods.

Though the inventory itself doesn’t change between finished goods and distribution inventory, a place value is added in case of distribution inventory.

All these four types of inventory are the purpose of the business and that is the very reason the entire organisation exists.

Maintenance, Repair and Operating Supplies forms a special type of inventory. This is required to support the production processes.

The tools, spare parts, consumables, lubricants and cleaning supplies form MRO. Normally MRO is managed by the maintenance department and it is typically stored in MRO Store.

Maintenance department procures the MRO and issues it to the maintenance and engineering teams as and when needed.

Based on your production environment your classification of the material may differ. Here production environment refers to what do you do in your factory.

Steel sheet may be called as finished goods by a steel rolling company, but as an automobile company you may call it as raw material.

Spark plug may be called as finished goods by a company but classified as a component by a motorcycle company. A company that uses a generator may classify the same spark plug as MRO.

Hope you understand that the classification of these inventory types depends on your production environment.

Inventory is the term we use to refer to all production materials and those that support the production processes like MRO. Companies small and large, manufacturing or services have inventory.

Manufacturing companies buy raw materials and add value on top of it then sell it as finished goods. On the other hand, retail companies buy these finished goods and make it available to the consumers.

For a typical manufacturing company inventory purchase in a year forms as high as 70% of its turnover. Here 20% may be the cost of value addition and the rest 10% is their profit.