Inventory is all the raw materials, work in process, and finished products that are considered a part of a company’s assets that will be ready for sale. Depending on the type of business you have there are different ways of accounting for your inventory. Setting up an inventory system will depend on how you plan to account for your inventory. If you have many raw materials you may have a system where all materials enter an accounting system at the time of purchase or you may assign all materials purchased to a general ledger account and manually account for your inventory through a general ledger as opposed to an inventory system.
Inventory can be a labor intensive part of a business and setting up a system will be determined by how well you want to manage your inventory. There is a cost to manage your inventory but there is also a cost to not managing your inventory. When you don’t manage your inventory you are vulnerable to theft, breakage, non receipt of merchandise, incorrect quantities of merchandise received, cost variances on materials, incorrect products received, billed for products never shipped, etc.
Managing inventory also helps in managing your revenues. When inventory has been sent out but no sale invoice has been entered it is at this point you will realize your client was not billed. Mistakes happen in all areas of business and sales invoicing is no exception. By managing your inventory you are also managing your sales revenue.
Inventory counting is done at least once a year to adjust or match the inventory listed on your financial statements. Some companies spot check their inventory by counting different segments of their inventory monthly or quarterly. Identifying problem areas sooner than later will help to ensure your costs are not unpredictable at year end. Theft of inventory by customers, employees, delivery personal, vendors, etc comes off your bottom line ….out of your profit. You don’t want to spend $5 to account for $1 so you have to understand your inventory process.
Your inventory process starts the day you purchase inventory. The purchase invoice must be paid and accounted for. Once the inventory is delivered it must be accounted for and stored. If it goes from box to showroom to sale to customer you have a very short inventory process. If you are purchasing raw materials they must be stored, processed into an inventory item for resale and stored again. Raw materials may be accounted for as a raw material, a work in process/unfinished inventory item, or a finished inventory item each with their own assigned cost. Understanding your inventory flow will help you to set up a system that helps you reduce you inventory costs without incurring unreasonable inventory management costs.