Inventory Management Information @ LivingHandToMouse.com

Inventory is a list for goods In macroeconomics and accounting, a good is contrasted with a service. In this sense, a good is defined as a physical product, capable of being delivered to a purchaser and involves the transfer of ownership from seller to customer, say an apple, as opposed to an (intangible) service, say a haircut. A more general term that preserves the and materials Material is anything made of matter, constituted of one or more substances. Wood, cement, hydrogen, air and water are all examples of materials. Sometimes the term "material" is used more narrowly to refer to substances or components with certain physical properties that are used as inputs to production or manufacturing. In this sense,, or those goods and materials themselves, held available in stock by a business A business is a legally recognized organization designed to provide goods or services, or both, to consumers, businesses and governmental entities. Businesses are predominant in capitalist economies. Most businesses are privately owned. A business is typically formed to earn profit that will increase the wealth of its owners and grow the business. It is also used for a list of the contents of a household and for a list for testamentary A will or testament is a legal declaration by which a person, the testator, names one or more persons to manage his estate and provides for the transfer of his property at death. For the devolution of property not disposed of by will, see inheritance and intestacy purposes of the possessions of someone who has died. In accounting inventory is considered an asset In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset. Simplistically stated, assets represent ownership of value that can be converted into cash . The balance sheet of a firm.

In business management, inventory consists of a list of goods and materials held available in stock.

Labels: Inventory Management, Procurement, Supply Chain, Supply Chain Management

Inventory Management

Inventory management is primarily about specifying the size and placement of stocked goods. Inventory management is required at different locations within a facility or within multiple locations of a supply network to protect the regular and planned course of production against the random disturbance of running out of materials or goods. The scope of inventory management also concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns and defective goods and demand forecasting. Balancing these competing requirements leads to optimal inventory levels, which is an on-going process as the business needs shift and react to the wider environment.

Other definitions of inventory management from across the web:

Involves a retailer seeking to acquire and maintain a proper merchandise assortment while ordering, shipping, handling, and related costs are kept in check.

Systems and processes that identify inventory requirements, set targets, provide replenishment techniques and report actual and projected inventory status.

Handles all functions related to the tracking and management of material. This would include the monitoring of material moved into and out of stockroom locations and the reconciling of the inventory balances. Also may include ABC analysis ABC analysis is a business term used to define an inventory categorization technique often used in materials management. It is also known as Selective Inventory Control, lot tracking, cycle counting support etc.

Management of the inventories, with the primary objective of determining/controlling stock levels within the physical distribution function to balance the need for product availability against the need for minimizing stock holding and handling costs. See inventory proportionality.

Business inventory

The reasons for keeping stock

There are three basic reasons for keeping an inventory:

Time - The time lags present in the supply chain, from supplier to user at every stage, requires that you maintain certain amount of inventory to use in this "lead time".
Uncertainty - Inventories are maintained as buffers to meet uncertainties in demand, supply and movements of goods.
Economies of scale - Ideal condition of "one unit at a time at a place where user needs it, when he needs it" principle tends to incur lots of costs in terms of logistics. So bulk buying, movement and storing brings in economies of scale, thus inventory.

All these stock reasons can apply to any owner or product stage.

Buffer stock is held in individual workstations against the possibility that the upstream workstation may be a little delayed in long setup or change-over time. This stock is then used while that change-over is happening. This stock can be eliminated by tools like SMED Single-Minute Exchange of Die is one of the many lean production methods for reducing waste in a manufacturing process. It provides a rapid and efficient way of converting a manufacturing process from running the current product to running the next product. This rapid changeover is key to reducing production lot sizes and thereby improving flow (.

These classifications apply along the whole Supply chain A supply chain is a system of organizations, people, technology, activities, information and resources involved in moving a product or service from supplier to customer. Supply chain activities transform natural resources, raw materials and components into a finished product that is delivered to the end customer. In sophisticated supply chain not just within a facility or plant.

Where these stocks contain the same or similar items it is often the work practice to hold all these stocks mixed together before or after the sub-process to which they relate. This 'reduces' costs. Because they are mixed-up together there is no visual reminder to operators of the adjacent sub-processes or line management Line management is the work of a business manager to administrate the enterprise activities that contribute directly to the output of products or services. In a corporate hierarchy, a line manager will hold authority over a vertical product line or chain of command. They are charged with meeting corporate objectives in a specific functional area of the stock which is due to a particular cause and should be a particular individual's responsibility with inevitable consequences. Some plants have centralized stock holding across sub-processes which makes the situation even more acute.

Special terms used in dealing with inventory

Stock Keeping Unit A stock-keeping unit or SKU is a unique identifier for each distinct product and service that can be purchased. SKU use is rooted in data management, enabling the company to systematically track its inventory or product availability, such as in warehouses and retail outlets. They are often assigned and serialized at the merchant level. Each SKU is (SKU) is a unique combination of all the components that are assembled into the purchasable item. Therefore any change in the packaging or product is a new SKU. This level of detailed specification assists in managing inventory.
Stockout means running out of the inventory of an SKU.^[1]
"New old stock The term refers to merchandise being offered for sale which was manufactured long ago but that has never been used. Such merchandise may not be produced anymore, and the new old stock may represent the only market source of a particular item at the present time" (sometimes abbreviated NOS) is a term used in business to refer to merchandise being offered for sale which was manufactured long ago but that has never been used. Such merchandise may not be produced any more, and the new old stock may represent the only market source of a particular item at the present time.

Typology

Buffer/safety stock
Cycle stock (Used in batch processes, it is the available inventory excluding buffer stock)
De-coupling (Buffer stock that is held by both the supplier and the user)
Anticipation stock (building up extra stock for periods of increased demand - e.g. ice cream for summer)
Pipeline stock (goods still in transit or in the process of distribution - have left the factory but not arrived at the customer yet)

Inventory examples

While accountants An accountant is a practitioner of accountancy , which is the measurement, disclosure or provision of assurance about financial information that helps managers, investors, tax authorities and other decision makers make resource allocation decisions often discuss inventory in terms of goods for sale, organizations - manufacturers Manufacturing is the use of machines, tools and labor to make things for use or sale. Also it can be used for selling things. The term may refer to a range of human activity, from handicraft to high tech, but is most commonly applied to industrial production, in which raw materials are transformed into finished goods on a large scale. Such, service-providers A service provider is an entity that provides services to other entities. Usually this refers to a business that provides subscription or web service to other businesses or individuals. Examples of these services include Internet access, Mobile phone operator, and web application hosting. The term is more often applied to communication services and not-for-profits A non-profit organization is an organization that does not distribute its surplus funds to owners or shareholders, but instead uses them to help pursue its goals. Examples of NPOs include charities (i.e. charitable organizations), trade unions, and public arts organizations. Most governments and government agencies meet this definition, but in - also have inventories (fixtures, furniture, supplies, ...) that they do not intend to sell. Manufacturers', distributors Physical distribution is one of the four elements of the marketing mix. An organization or set of organizations (go-betweens) involved in the process of making a product or service available for use or consumption by a consumer or business user', and wholesalers' inventory tends to cluster in warehouses A warehouse is a commercial building for storage of goods. Warehouses are used by manufacturers, importers, exporters, wholesalers, transport businesses, customs, etc. They are usually large plain buildings in industrial areas of cities and towns. They usually have loading docks to load and unload goods from trucks. Sometimes warehouses load and. Retailers Retailing consists of the sale of goods or merchandise from a fixed location, such as a department store, boutique or kiosk, or by mail, in small or individual lots for direct consumption by the purchaser. Retailing may include subordinated services, such as delivery. Purchasers may be individuals or businesses. In commerce, a "retailer"' inventory may exist in a warehouse or in a shop Retailing consists of the sale of goods or merchandise from a fixed location, such as a department store, boutique or kiosk, or by mail, in small or individual lots for direct consumption by the purchaser. Retailing may include subordinated services, such as delivery. Purchasers may be individuals or businesses. In commerce, a "retailer" or store accessible to customers A customer, also called client, buyer, or purchaser, is usually used to refer to a current or potential buyer or user of the products of an individual or organization, called the supplier, seller, or vendor. This is typically through purchasing or renting goods or services. However, in certain contexts, the term customer also includes by extension. Inventories not intended for sale to customers or to clients Consumer is a broad label for any individuals or households that use goods and services generated within the economy. The concept of a consumer occurs in different contexts, so that the usage and significance of the term may vary may be held in any premises an organization uses. Stock ties up cash and if uncontrolled it will be impossible to know the actual level of stocks and therefore impossible to control them.

While the reasons for holding stock are covered earlier, most manufacturing organizations usually divide their "goods for sale" inventory into:

Raw materials A raw material is something that is acted upon or used by or by human labor or industry, for use as a building material to create some product or structure.[citation needed] Often the term is used to denote material that came from nature and is in an unprocessed or minimally processed state. Iron ore, logs, and crude oil, would be examples. A non- - materials and components scheduled for use in making a product.
Work in process Work in process or in-process inventory includes the set at large of unfinished items for products in a production process. These items are not yet completed but either just being fabricated or waiting in a queue for further processing or in a buffer storage. The term is used in production and supply chain management, WIP - materials and components that have begun their transformation to finished goods.
Finished goods Finished goods are goods that have completed the manufacturing process but have not yet been sold or distributed to the end user - goods ready for sale to customers.
Goods for resale - returned goods that are salable.

For example:

Manufacturing

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A canned food manufacturer's materials inventory includes the ingredients to form the foods to be canned, empty cans and their lids (or coils of steel or aluminum for constructing those components), labels, and anything else (solder, glue, ...) that will form part of a finished can. The firm's work in process includes those materials from the time of release to the work floor until they become complete and ready for sale to wholesale or retail customers. This may be vats of prepared food, filled cans not yet labelled or sub-assemblies of food components. It may also include finished cans that are not yet packaged into cartons or pallets. Its finished good inventory consists of all the filled and labelled cans of food in its warehouse that it has manufactured and wishes to sell to food distributors (wholesalers), to grocery stores (retailers), and even perhaps to consumers through arrangements like factory stores An outlet store or factory outlet or "Best Saving Outlet" is a retail store in which manufacturers sell their stock directly to the public through their own branded stores. The stores can be brick and mortar or online. Traditionally, a factory outlet was a store, attached to a factory or warehouse. Often these stores are grouped together and outlet centers.

Examples of case studies are very revealing, and consistently show that the improvement of inventory management has two parts: the capability of the organisation to manage inventory, and the way in which it chooses to do so. For example, a company may wish to install a complex inventory system, but unless there is a good understanding of the role of inventory and its perameters, and an effective business process to support that, the system cannot bring the necessary benefits to the organisation in isolation.

Typical Inventory Management techniques include Pareto Curve ABC Classification and Economic Order Quantity Management. A more sophisticated method takes these two techniques further, combining certain aspects of each to createThe K Curve Methodology. A case study of k-curve benefits to one company shows a successful implementation.

Unnecessary inventory adds enormously to the working capital tied up in the business as well as the complexity of the supply chain. Reduction and elimination of these inventory 'wait' states is a key concept in Lean. Too big an inventory reduction too quickly can cause a business to be anorexic. There are well proven processes and techniques to assist in inventory planning and strategy, both at business overview and part number level. Many of the big MRP/and ERP systems do not offer the necessary inventory planning tools within their integrated planning applications.

Principle of inventory proportionality

Purpose

Inventory proportionality is the goal of demand driven inventory management. The primary optimal outcome is to have the same number of days (or hours, etc.) worth of inventory on hand across all products so that the time of runout of all products would be simultaneous. In such a case, there is no "excess inventory", that is , inventory that would be left over of another product when the first product runs out. Excess inventory is sub-optimal because the money spent to obtain it could have been deployed better elsewhere, i.e. to the product that just ran out.

The secondary goal of inventory proportionality is inventory minimization. By integrating accurate demand forecasting Demand forecasting is the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data or current data from test markets. Demand forecasting may be used in with inventory management, replenishment inventories can be scheduled to arrive just in time to replenish the product destined to run out first, while at the same time balancing out the inventory supply of all products to make their inventories more proportional, and thereby closer to achieving the primary goal. Accurate demand forecasting also allows the desired inventory proportions to be dynamic by determining expected sales out into the future; this allows for inventory to be in proportion to expected short term sales or consumption rather than to past averages, a much more accurate and optimal outcome.

Integrating demand forecasting with inventory management in this way also allows for the prediction of the "can fit" point when inventory storage is limited on a per product basis.

Applications

The technique of inventory proportionality is most appropriate for inventories that remain unseen by the consumer. As opposed to "keep full" systems where a retail consumer would like to see full shelves of the product they are buying so as not to think they are buying something old, unwanted, or stale; and differentiated from the "trigger point" systems where product is reordered when it hits a certain level; inventory proportionality is used effectively by just-in-time manufacturing processes and retail applications where the product is hidden from view.

One early example of inventory proportionality used in a retail application in the United States is for motor fuel. Motor fuel (e.g. gasoline) is generally stored in underground storage tanks. The motorists do not know whether they are buying gasoline off the top or bottom of the tank, nor need they care. Additionally, these storage tanks have a maximum capacity and cannot be overfilled. Finally, the product is expensive. Inventory proportionality is used to balance the inventories of the different grades of motor fuel, each stored in dedicated tanks, in proportion to the sales of each grade. Excess inventory is not seen or valued by the consumer, so it is simply cash sunk (literally) into the ground. Inventory proportionality minimizes the amount of excess inventory carried in underground storage tanks. This application for motor fuel was first developed and implemented by Petrolsoft Corporation in 1990 for Chevron Products Company. Most major oil companies use such systems today.^[2]

Roots

The use of Inventory Proportionality in the United States is thought to have been inspired by Japanese just-in-time (business) Just-in-time is an inventory strategy that strives to improve a business's return on investment by reducing in-process inventory and associated carrying costs. To meet JIT objectives, the process relies on signals or Kanban (看板, Kanban?) between different points in the process, which tell production when to make the next part. Kanban are parts inventory management made famous by Toyota Toyota Motor Corporation , commonly known simply as Toyota and abbreviated as TMC, is a multinational corporation headquartered in Japan. In 2009, Toyota Motor Corporation employed 71,116 people worldwide (total Toyota 320,808). TMC is the world's largest automobile maker by sales and production Motors in the 1980s.[3]

High level inventory management

It seems that around about 1880^[3] there was a change in manufacturing practice from companies with relatively homogeneous lines of products to vertically integrated companies with unprecedented diversity in processes and products. Those companies (especially in metalworking) attempted to achieve success through economies of scope - the gains of jointly producing two or more products in one facility. The managers now needed information on the effect of product mix decisions on overall profits and therefore needed accurate product cost information. A variety of attempts to achieve this were unsuccessful due to the huge overhead of the information processing of the time. However, the burgeoning need for financial reporting after 1900 created unavoidable pressure for financial accounting Financial accountancy is the field of accountancy concerned with the preparation of financial statements for decision makers, such as stockholders, suppliers, banks, employees, government agencies, owners, and other stakeholders. Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power of stock and the management need to cost manage products became overshadowed. In particular it was the need for audited accounts that sealed the fate of managerial cost accounting. The dominance of financial reporting accounting over management accounting Management accounting or managerial accounting is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions remains to this day with few exceptions and the financial reporting definitions of 'cost' have distorted effective management 'cost' accounting since that time. This is particularly true of inventory.

Hence high level financial inventory has these two basic formulas which relate to the accounting period:

The benefit of these formulae is that the first absorbs all overheads of production and raw material costs in to a value of inventory for reporting. The second formula then creates the new start point for the next period and gives a figure to be subtracted from sales price to determine some form of sales margin figure.

Manufacturing management is more interested in inventory turnover ratio or average days to sell inventory since it tells them something about relative inventory levels.

Inventory turn over ratio (also known as inventory turns In accounting, the Inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year. The equation for inventory turnover equals the cost of goods sold divided by the average inventory. Inventory turnover is also known as inventory turns, stockturn, stock turns, turns, and stock turnover) = cost of goods sold / Average Inventory = Cost of Goods Sold / ((Beginning Inventory + Ending Inventory) / 2)

and its inverse

Average Days to Sell Inventory = Number of Days a Year / Inventory Turn Over Ratio = 365 days a year / Inventory Turn Over Ratio

This ratio estimates how many times the inventory turns over a year. This number tells us how much cash/goods are tied up waiting for the process and is a critical measure of process reliability and effectiveness. So a factory with two inventory turns has six months stock on hand which generally not a good figure (depending upon industry) whereas a factory that moves from six turns to twelve turns has probably improved effectiveness by 100%. This improvement will have some negative results in the financial reporting since the 'value' now stored in the factory as inventory is reduced.

Whilst the simplicity of these accounting measures of inventory are very useful they are in the end fraught with the danger of their own assumptions. There are in fact so many things which can vary hidden under this appearance of simplicity that a variety of 'adjusting' assumptions may be used. These include:

Inventory Turn is a financial accounting tool for evaluating inventory and it is not necessarily a management tool. Inventory management should be forward looking. The methodology applied is based on historical cost of goods sold. The ratio may not be able to reflect the usability of future production demand as well as customer demand.

Business models including Just in Time (JIT) Inventory, Vendor Managed Inventory (VMI) and Customer Managed Inventory (CMI) attempt to minimize on-hand inventory and increase inventory turns. VMI and CMI have gained considerable attention due to the success of third party vendors who offer added expertise and knowledge that organizations may not possess.

Accounting for Inventory

Each country has its own rules about accounting Accountancy is the art of communicating financial information about a business entity to users such as shareholders and managers. The communication is generally in the financial´s form statements that show in money terms the economic resources under the control of management; the art lies in selecting the information that is relevant to the user for inventory that fit with their financial reporting rules.

So for example, organizations in the U.S. define inventory to suit their needs within US Generally Accepted Accounting Practices In the U.S., generally accepted accounting principles, commonly abbreviated as US GAAP or simply GAAP, are accounting rules used to prepare, present, and report financial statements for a wide variety of entities, including publicly-traded and privately-held companies, non-profit organizations, and governments. Generally GAAP includes local (GAAP), the rules defined by the Financial Accounting Standards Board The Financial Accounting Standards Board is a private, not-for-profit organization whose primary purpose is to develop generally accepted accounting principles (GAAP) within the United States in the public's interest. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards (FASB) (and others) and enforced by the U.S. Securities and Exchange Commission The U.S. Securities and Exchange Commission is a federal agency which holds primary responsibility for enforcing the federal securities laws and regulating the securities industry, the nation's stock and options exchanges, and other electronic securities markets in the United States. In addition to the 1934 Act that created it, the SEC enforces (SEC) and other federal and state agencies. Other countries often have similar arrangements but with their own GAAP and national agencies instead.

It is intentional that financial accounting Financial accountancy is the field of accountancy concerned with the preparation of financial statements for decision makers, such as stockholders, suppliers, banks, employees, government agencies, owners, and other stakeholders. Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power uses standards that allow the public to compare firms' performance, cost accounting In management accounting, cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company's costs and improve profitability. As a form of management accounting, cost functions internally to an organization and potentially with much greater flexibility. A discussion of inventory from standard and Theory of Constraints The underlying premise of Theory of Constraints is that organizations can be measured and controlled by variations on three measures: throughput, operating expense, and inventory. Throughput is money generated through sales. Inventory is money the system invests in order to sell its goods and services. Operating expense is all the money the system-based (throughput In communication networks, such as Ethernet or packet radio, throughput or network throughput is the average rate of successful message delivery over a communication channel. This data may be delivered over a physical or logical link, or pass through a certain network node. The throughput is usually measured in bits per second , and sometimes in) cost accounting In management accounting, cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company's costs and improve profitability. As a form of management accounting, cost perspective follows some examples and a discussion of inventory from a financial accounting Financial accountancy is the field of accountancy concerned with the preparation of financial statements for decision makers, such as stockholders, suppliers, banks, employees, government agencies, owners, and other stakeholders. Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power perspective.

The internal costing/valuation of inventory can be complex. Whereas in the past most enterprises ran simple one process factories, this is quite probably in the minority in the 21st century. Where 'one process' factories exist then there is a market for the goods created which establishes an independent market value for the good. Today with multi-stage process companies there is much inventory that would once have been finished goods which is now held as 'work-in-process' (WIP). This needs to be valued in the accounts but the valuation is a management decision since there is no market for the partially finished product. This somewhat arbitrary 'valuation' of WIP combined with the allocation of overheads to it has led to some unintended and undesirable results.

Financial accounting

An organization's inventory can appear a mixed blessing, since it counts as an asset on the balance sheet, but it also ties up money that could serve for other purposes and requires additional expense for its protection. Inventory may also cause significant tax expenses, depending on particular countries' laws regarding depreciation of inventory, as in Thor Power Tool Company v. Commissioner.

Inventory appears as a current asset on an organization's balance sheet because the organization can, in principle, turn it into cash by selling it. Some organizations hold larger inventories than their operations require in order to inflate their apparent asset value and their perceived profitability.

In addition to the money tied up by acquiring inventory, inventory also brings associated costs for warehouse space, for utilities, and for insurance to cover staff to handle and protect it, fire and other disasters, obsolescence, shrinkage (theft and errors), and others. Such holding costs can mount up: between a third and a half of its acquisition value per year.

Businesses that stock too little inventory cannot take advantage of large orders from customers if they cannot deliver. The conflicting objectives of cost control and customer service often pit an organization's financial and operating managers against its sales and marketing departments. Sales people, in particular, often receive sales commission payments, so unavailable goods may reduce their potential personal income. This conflict can be minimised by reducing production time to being near or less than customer expected delivery time. This effort, known as "Lean production" will significantly reduce working capital tied up in inventory and reduce manufacturing costs (See the Toyota Production System).

Role of Inventory Accounting

By helping the organization to make better decisions, the accountants can help the public sector to change in a very positive way that delivers increased value for the taxpayer’s investment. It can also help to incentivise progress and to ensure that reforms are sustainable and effective in the long term, by ensuring that success is appropriately recognized in both the formal and informal reward systems of the organization.

To say that they have a key role to play is an understatement. Finance is connected to most, if not all, of the key business processes within the organization. It should be steering the stewardship and accountability systems that ensure that the organization is conducting its business in an appropriate, ethical manner. It is critical that these foundations are firmly laid. So often they are the litmus test by which public confidence in the institution is either won or lost.

Finance should also be providing the information, analysis and advice to enable the organizations’ service managers to operate effectively. This goes beyond the traditional preoccupation with budgets – how much have we spent so far, how much have we left to spend? It is about helping the organization to better understand its own performance. That means making the connections and understanding the relationships between given inputs – the resources brought to bear – and the outputs and outcomes that they achieve. It is also about understanding and actively managing risks within the organization and its activities.

FIFO vs. LIFO accounting

Main article: FIFO and LIFO accounting

When a merchant buys goods from inventory, the value of the inventory account is reduced by the cost of goods sold (CoG sold). This is simple where the CoG has not varied across those held in stock; but where it has, then an agreed method must be derived to evaluate it. For commodity items that one cannot track individually, accountants must choose a method that fits the nature of the sale. Two popular methods which normally exist are: FIFO and LIFO accounting (first in - first out, last in - first out). FIFO regards the first unit that arrived in inventory as the first one sold. LIFO considers the last unit arriving in inventory as the first one sold. Which method an accountant selects can have a significant effect on net income and book value and, in turn, on taxation. Using LIFO accounting for inventory, a company generally reports lower net income and lower book value, due to the effects of inflation. This generally results in lower taxation. Due to LIFO's potential to skew inventory value, UK GAAP and IAS have effectively banned LIFO inventory accounting.

Standard cost accounting

Standard cost accounting uses ratios called efficiencies that compare the labour and materials actually used to produce a good with those that the same goods would have required under "standard" conditions. As long as similar actual and standard conditions obtain, few problems arise. Unfortunately, standard cost accounting methods developed about 100 years ago, when labor comprised the most important cost in manufactured goods. Standard methods continue to emphasize labor efficiency even though that resource now constitutes a (very) small part of cost in most cases.

Standard cost accounting can hurt managers, workers, and firms in several ways. For example, a policy decision to increase inventory can harm a manufacturing managers' performance evaluation. Increasing inventory requires increased production, which means that processes must operate at higher rates. When (not if) something goes wrong, the process takes longer and uses more than the standard labor time. The manager appears responsible for the excess, even though s/he has no control over the production requirement or the problem.

In adverse economic times, firms use the same efficiencies to downsize, rightsize, or otherwise reduce their labor force. Workers laid off under those circumstances have even less control over excess inventory and cost efficiencies than their managers.

Many financial and cost accountants have agreed for many years on the desirability of replacing standard cost accounting. They have not, however, found a successor.

Theory of Constraints cost accounting

Eliyahu M. Goldratt developed the Theory of Constraints in part to address the cost-accounting problems in what he calls the "cost world". He offers a substitute, called throughput accounting, that uses throughput (money for goods sold to customers) in place of output (goods produced that may sell or may boost inventory) and considers labor as a fixed rather than as a variable cost. He defines inventory simply as everything the organization owns that it plans to sell, including buildings, machinery, and many other things in addition to the categories listed here. Throughput accounting recognizes only one class of variable costs: the trully variable costs like materials and components that vary directly with the quantity produced.

Finished goods inventories remain balance-sheet assets, but labor efficiency ratios no longer evaluate managers and workers. Instead of an incentive to reduce labor cost, throughput accounting focuses attention on the relationships between throughput (revenue or income) on one hand and controllable operating expenses and changes in inventory on the other. Those relationships direct attention to the constraints or bottlenecks that prevent the system from producing more throughput, rather than to people - who have little or no control over their situations.

National accounts

Inventories also play an important role in national accounts and the analysis of the business cycle. Some short-term macroeconomic fluctuations are attributed to the inventory cycle.

Distressed inventory

Also known as distressed or expired stock, distressed inventory is inventory whose potential to be sold at a normal cost has or will soon pass. In certain industries it could also mean that the stock is or will soon be impossible to sell. Examples of distressed inventory include products that have reached their expiry date, or have reached a date in advance of expiry at which the planned market will no longer purchase them (e.g. 3 months left to expiry), clothing that is defective or out of fashion, and old newspapers or magazines. It also includes computer or consumer-electronic equipment that is obsolescent or discontinued and whose manufacturer is unable to support it. One current example of distressed inventory is the VHS format.^[4]

In 2001 Cisco write off inventory worth of US $2.25 billion due to duplicate orders ^[5]. This is one of the biggest write off of inventory in business history of the world.

Inventory credit

Inventory credit refers to the use of stock, or inventory, as collateral to raise finance. Where banks may be reluctant to accept traditional collateral, for example in developing countries where land title may be lacking, inventory credit is a potentially important way of overcoming financing constraints. This is not a new concept; archaeological evidence suggests that it was practiced in Ancient Rome. Obtaining finance against stocks of a wide range of products held in a bonded warehouse is common in much of the world. It is, for example, used with Parmesan cheese in Italy.^[6] Inventory credit on the basis of stored agricultural produce is widely used in Latin American countries and in some Asian countries. ^[7] A precondition for such credit is that banks must be confident that the stored product will be available if they need to call on the collateral; this implies the existence of a reliable network of certified warehouses. Banks also face problems in valuing the inventory. The possibility of sudden falls in commodity prices means that they are usually reluctant to lend more than about 60% of the value of the inventory at the time of the loan.

References

^ Financial dictionary, formerly at http://www.specialinvestor.com/terms/1072.html, Special Investor
^ aspenONE® Supply & Distribution for Refining & Marketing, http://www.aspentech.com/solutions/industry_solutions/refining_marketing/aspenone_supply_distribution.cfm
^ Relevance Lost, Johnson and Kaplan, Harvard Business School Press, 1987, p126
^ Boucher, Geoff (2008-12-22). "VHS era is winding down". Los Angeles Times. http://www.latimes.com/entertainment/news/la-et-vhs-tapes22-2008dec22,0,5852342.story. Retrieved 2008-12-28.
^ {|last=Armony |first=Mor |title=The Impact of Duplicate Orders on Demand Estimation and Capacity Investment |http://ormstomorrow.informs.org/archive/Summerfall06/TheImpactOfDuplicateOrders.pdf}
^ Italian Notebook.com [1]"Who moved my parmigiano?" 24 February 2009
^ Jonathan Coulter and Andrew W. Shepherd [2], Inventory Credit – An approach to developing agricultural markets, FAO, Rome, 1995

This article needs additional citations for verification. Please help improve this article by adding reliable references. Unsourced material may be and removed. (March 2008)

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