The Four Types of Inventory in the Supply Chain

The most financially successful companies in the world don’t get that way by chance. Rather, they take time and put in effort to hire the right number of qualified employees and practice sound business principles. This way, they can make enough money to thrive.

But in some cases, companies fail to turn a profit because they mismanage their inventory. “Inventory” refers to the sum of all products or services that businesses intend to sell, whether to end users or other businesses. It applies to all stages of the product or service from its creation through to its completion and final sale. Professionals involved in a business’s supply chain should have a working knowledge of inventory management and the main types of inventory.

 Inventory management is a crucial function for retail and manufacturing businesses whose main goal is to sell goods or services. Carefully addressing inventory helps to minimize cost on a company’s balance sheet whenever that company orders shipments of goods. For a large corporation or small business to thrive, its leader should be skilled in proper inventory accounting practices, including procuring enough stock and identifying potential product shortages.

 While inventory spans a variety of specific types, there are four major ones to make note of. These include raw materials and components, work-in-progress items, finished goods, and maintenance, repair, and operating (MRO) supplies.

For businesses of all sizes, inventory management is a necessary process for maximizing profit and minimizing loss. Because a complete supply chain comprises so many moving parts, businesses must implement systems to keep track of their inventory. And as a business grows, so does its inventory and the need to manage it efficiently.

 Most organizations use the following systems to manage inventory:

•  Mental notes and intuition. While some individuals may try to track inventory on their own, no business should rely on it.
• Paper-based solutions. With a bigger inventory comes the need to record lists on documents like notepads or ledgers.
• Excel-based management. It’s common for companies of all sizes to track their inventory via Excel, QuickBooks, or some other spreadsheet-based software program. A virtual spreadsheet is convenient and useful for tracking large and small inventories.
• Dedicated inventory management software. For most multinational or otherwise expansive organizations, specialized inventory management software might be necessary to help oversee all steps of the supply chain.

Businesses rely on effective inventory management to control the flow of inventory at different levels. For example, a shoe manufacturer engages in inventory management when it identifies what and how much stock to order at what time. This way, the manufacturer can equip itself for potential disturbances in the supply-and-demand cycle of the economic climate. 

Managing inventory involves all phases of the supply chain. These phases include:

1. Purchasing. A business needs to buy supplies before it can begin building and selling a product. Special attention should be paid to how much is bought and when.
2. Production. Next comes putting together components and turning them into usable products for consumers or other businesses. These products might include books, clothing, electronics, construction equipment, packaged foods, and much more.
3. Stock Holding. Many businesses keep extra stock on hand—sometimes called “safety stock”—to prepare for unforeseen events, to avoid stock shortages, or to save money in the long run.
4. Sales. One of the final steps of a supply chain is for a business to sell finished products for consumer use. Sales management includes anticipating demand, identifying buyers, and delivering products.
5. Reporting. Once a sale is made, inventory managers should keep a record of all data around the product from creation to delivery. Reporting and recording this data can keep the process running smoothly, especially for future inventory management efforts.

Running an efficient supply chain requires knowing how to group and track physical items into the following four categories, from beginning to end:

1. Raw Materials. Raw materials are the basic building blocks for creating a product intended for sale. They’re the initial pieces needed to form the finished product. Most raw materials are made by manufacturing companies that specialize in producing them for sale to other businesses. Examples of raw materials include plastic, rubber, wood, oil, fabric, and metal. They can be further broken down into two categories.

• Direct—actual material used in the final product.
• Indirect—materials or items not in the final product but used to help create it, like a factory lift or a conveyor belt, for instance.

2. Work-in-Progress Items. This type of inventory refers to anything in the supply chain currently being made or worked on. Raw materials, packaging materials, and other similar components make up the bulk of work-in-progress items. It can include both direct and indirect raw materials, but the products in this category are not yet complete. An example of a work-in-progress item could be paper for a book manufacturer or textiles for a furniture store.

3.  Finished Goods. These products are just that—finished and ready for sale and use. Finished goods can be made to order or made to stock. Make-to-order (MTO) goods are those that a business or customer orders beforehand while make-to-stock (MTS) goods are stored until purchase. Supply and demand principles determine the type of finished goods made. Examples of finished goods include boxes of shoes, canned tuna, and packaged iPads.

 4. Maintenance, Repair, and Operating (MRO) Supplies. MRO supplies make up all the miscellaneous items that companies use to build products. These supplies might be kept in the warehouse, in storage, or in a delivery van. Anything from screwdrivers or hydraulic presses to simple brooms could qualify as MRO supplies.

Supply chains can be sophisticated, especially in today’s global economy. Many other categories of inventory exist alongside the four main types to help define inventory management.

• Components. These tend to be small items included in a finished good that are part of its construction, like screws, nails, or bolts.
• Packing and packaging materials. Finished products need to be properly packaged to remain in good condition for sale. Businesses use materials like Styrofoam, tape, and staples for this purpose.
• Safety stock and anticipation stock. This is the extra stock that companies may hold onto in case of unexpected events like shortages. Keeping safety stock costs money but can be a wise choice, especially if the prices of raw materials or components rise.
• Decoupling inventory. Some manufacturers keep extra supplies along a production line or at workstations to keep production flowing smoothly in case of delays.
• Transit inventory. Any product being delivered from a company to an end user or to a storage facility would be considered transit inventory.
• Cycle inventory. Cycle inventory includes whatever is currently available to meet demand.
• Service inventory. While less tangible, service inventory is still an asset to certain businesses, including those in food service and hospitality. It refers to the amount of service that can be rendered in a certain period.
• Theoretical inventory. This type of inventory defines the least amount of stock needed for a company to produce a final good without delay.

Managing inventory effectively matters because it can help businesses understand how to buy the right amount of stock at the right time. The high-level goal of inventory management is to generate a steady stream of revenue for an organization. Managers, workers, and other individuals in an organization can’t achieve this unless they have a measurable influence on the supply chain in question.

Inventory managers are crucial to the global business economy because their work prevents excessive corporate costs and frees up company assets for the more thorough planning of smarter investments as well as evaluations of accounts, financial reports, and more. Careful inventory management empowers companies to meet customer demand and remain financially flexible.

There’s no one-size-fits-all method to inventory management. One company’s approach may differ from another depending on its size, business model, and client base. A business dealing in exercise equipment might adopt a first-in, first-out (FIFO) method when they sell their finished products, while a burger restaurant may use a last-in, first-out (LIFO) method when serving their customers.

 The best ways to manage inventory should be determined by company leadership who specialize in supply chain management. They should keep in mind that they won’t be able to grow their business unless they understand and control their inventory.

 If you’re looking to work in inventory management, consider WGU. We offer programs like business management and supply chain and operations management that can help you acquire the skills to successfully manage inventory. Our business programs are online, accredited, and designed with input by industry experts, so you can earn a respected degree at a pace that works for you.

Plus, through WGU’s competency-based education model, you can progress through your studies as fast as you master the material and take assessments when you’re ready.