- Finished goods – completed products that are ready for sale to the customer.
- Work-in-process – products in semi-finished form that require additional material and/or more labor before becoming finished goods.
- Raw materials – items on which no labor has been expended that are to be incorporated into finished goods before completion.
- Indirect materials – materials and supplies that aid in the production of finished goods but which do not become part of the finished product. In service or other similar companies where there is no finished goods inventory, these may also be supply type items that are used specifically and directly in the provision of services.
Inventory management will have a direct impact on the profitability of your company. It can be either a positive impact or a negative impact, but it will have an impact. The answer to effective inventory management is a well-organized system of planning and control that is consistently followed. The level of sophistication is not the overriding issue; it is the continuous effort of monitoring the process and executing in accordance with the established management guidelines that will make the effort a success. A haphazard approach to inventory management is certain to result in a long list of unwanted surprises. Through the affect on profits, these surprises can dramatically change your expectation for cash flow. If the magnitude of the change is significant enough, the result can be devastating to the business.
The technical aspects of accounting for inventory management can be extremely complicated and require years of formal training to handle properly. Although the effect of these different accounting procedures on profitability can be quite significant, it is also relatively short-term in nature. Over time, the end result is basically the same. Your ability to manage inventory for maximum profitability is not predicated on understanding the details of these technical issues, that’s why there are accountants in the world.
The issues that drive true profitability and therefore cash flow (ignoring the accounting stuff) are more operational in nature. These are associated with the efficient and effective use of the inventory sitting on the shelf. The kinds of items that might be included in inventory for any particular company will vary widely and could possibly require different methods and techniques for managing each type. However, the ability to anticipate the correct purchase volumes to be ordered at the right time and to effectively distribute and make use of the various items are the keys to success.
