When e-commerce businesses talk about “inventory”, they’re usually referring to finished goods inventory — that is, the final product that is sold and shipped to end customers. However, there are many different types of inventory. If you manufacture or assemble your products, your supply chain will also involve something called raw materials inventory.
Raw materials inventory is procured, stored, and received before any other products in the supply chain, and is integral to producing enough high-quality final product.
In this article, we’ll cover what raw material inventory is, why it’s a critical element within your supply chain, how to calculate it, and best practices for procuring and managing it.
What Is the Raw Materials Inventory?
Raw material inventory is the calculated value of a company’s basic components that are used to build and manufacture its products. These items are called “pre-production inventory, ” meaning they’re currently in stock and waiting for use.
Companies and organizations often list raw material as a current assets when creating financial documents, such as a balance sheet, because of their contribution to a manufacturer’s overall product inventory.
There are two subcategories of raw materials:
Direct materials: Direct materials are items that companies incorporate into a final manufactured product. For example, when manufacturing blankets, the cloth or textile the company uses in creating the blanket would be a direct material.
Indirect materials: Indirect materials are components that are consumed to help make a final manufactured product that a company can’t easily measure or quantify. For example, if a company manufactures clocks and watches, the company would consider any oil used to lubricate the gears as an indirect material.
Why Is Raw Material Inventory Management Important?
Raw material inventory management is the process you or your managers will follow to ensure enough stock on hand, from direct materials to indirect materials, to keep production moving.
As your orders increase, you may order a ton of extra materials, assuming that the more safety stock you have, the better.
Well, imagine your raw material inventory was raw produce in a supermarket. Stocking up to last until next Christmas could be a bad move since perishable goods could expire. Even if your inventory never expires, holding too much of it will ultimately increase your carrying costs. This won’t be a small error — something like this could spell the end for your business.
Without a proper raw material inventory plan in place, you will drive up your manufacturing costs for no good reason.
Your raw materials may not spoil like supermarket produce, but the result of keeping large amounts of raw material stock around is the same. That’s why it’s important to understand your raw materials’ value and customer demand.
Importance of Mastering Your Raw Materials Inventory
Mastering raw material inventory is a strategic imperative for several compelling reasons:
Ensuring Production Continuity
Raw materials serve as the lifeblood of production. Any interruption in the supply of these materials can bring manufacturing processes to a grinding halt, leading to costly downtime and production delays.
Minimising Costs
Effective inventory management minimises carrying costs associated with holding excess raw material. Conversely, shortages can lead to higher prices due to rush orders and the premium pricing associated with urgency.
Meeting Customer Demand
Maintaining an adequate supply of raw materials ensures you can promptly meet customer demand. Delays caused by raw material shortages can lead to dissatisfied customers and lost business opportunities.
Reducing Lead Times
Well-managed raw material inventory allows for a rapid response to customer orders, reducing lead times and enhancing overall service levels.
Managing Supplier Relationships
A well-maintained raw material inventory enables smoother negotiations and relationships with suppliers. It allows for bulk purchasing, discounts, and favourable credit terms, strengthening the supply chain.
How To Calculate Raw Materials Inventory
You can calculate raw material inventory using this formula:
Raw materials inventory = beginning inventory + raw materials purchased – cost of goods sold
Here are steps to help you calculate raw material inventory:
Determine the time
When calculating raw material inventory, it’s important to determine the period you plan to use to find your values for the calculation. Determining the timeframe allows you to create accurate formula values. For example, if a company calculates raw material inventory for its reporting periods every three months, its formula values would come from the last three months of business.
Discover the value of the starting raw materials inventory
Before you can start making any calculations, it’s important to find the value of a company’s beginning raw material inventory. You can do this by taking all the direct and indirect material from the start of a specified period and adding up their costs to discover their total value. This is the ending raw material inventory from the previous accounting period.
Calculate the raw materials purchased
Keep track of any raw materials purchased throughout the predetermined period and then find the sum of those purchases. This allows you to calculate the value of raw material gained. Then, add that number to the value of starting raw materials inventory.
Subtract the cost of goods sold
Finally, take the total costs of all finished goods and products sold over the set period and subtract that number from the sum of starting raw material and raw materials purchased to calculate your raw material inventory.
Raw Materials Inventory Accounting
Keeping accurate records of raw materials purchases allows factories to monitor the progress of their initial investment. It then provides a reliable indicator of the businesses’ financial standing.
Accounting for Direct Raw Materials
If direct raw materials are used, a credit should be made to the raw materials inventory asset account, and a debit should be made to the WIP inventory account.
Use a reliable accounting resource to distinguish between identical debits and credits.
Accounting for Indirect Raw Materials
Debit the overhead expense account and credit the raw inventory asset account for any indirect raw materials used. The remaining overhead balance is recorded after the accounting period and then transferred to the cost of goods sold.
Accounting for Unusable Raw Materials Inventory
Unfortunately, raw materials sometimes become so outdated or damaged that they are no longer usable. Dead stock is a term for inventory that can’t be moved.
Anything expired, from raw materials to finished products, falls under the deadstock definition. When this occurs, the expense is often written off against raw materials and added to the cost of goods sold.
Best Practices for Raw Materials Inventory
Efficient management of raw materials inventory involves the implementation of best practices:
Demand Forecasting
Leverage historical data and market trends to forecast raw material requirements accurately. This minimises the risk of overstocking or shortages, enabling proactive inventory management.
Safety Stock
Maintain a safe stock of critical raw materials to safeguard against unexpected disruptions in supply chains, such as supplier delays or natural disasters.
Just-In-Time (JIT) Inventory
Implement a Just-In-Time (JIT) inventory system to reduce carrying costs and enhance responsiveness to demand fluctuations. This approach ensures that raw materials arrive precisely when they are needed, minimising waste and storage expenses.
Supplier Collaboration
Establish robust relationships with suppliers and communicate effectively to ensure a steady and reliable supply of raw materials. Collaborative relationships can lead to preferential pricing, better terms, and reliable deliveries.
Inventory Control Systems
Leverage technology, such as advanced inventory management software, to efficiently monitor and control raw-materials inventory levels. These systems provide real-time visibility into inventory, enabling data-driven decision-making.
Regular Audits
Conduct routine audits to verify inventory accuracy and identify discrepancies promptly. Regular audits maintain data integrity and contribute to better decision-making.
FIFO and LIFO
Select an inventory valuation methodology that impeccably aligns with the necessities of your business while seamlessly harmonising with your accounting protocols. Contemplative options such as the First-In, First-Out (FIFO) or the Last-In, First-Out (LIFO) methods wield a profound influence over the valuation of your raw-materials inventory and exert a palpable impact on the tapestry of financial reporting.
Sustainability Considerations
Incorporate sustainability considerations into your raw materials sourcing practices. Sustainable sourcing aligns with environmental and corporate responsibility goals, appealing to socially conscious consumers and investors.
FAQ: Raw Materials Inventory
Could raw material stockpiles be discarded altogether?
Removing raw materials stock completely may be difficult, so, businesses can use drop shipping or just-in-time production strategies to cut inventory levels and run smoothly.
How do you track the inventory of raw materials?
Raw-materials inventory can be tracked through various methods, including inventory management software, barcode systems, and regular manual counts.
How long is the life of raw materials inventory?
The life of raw-material inventory differs depending on the type of goods, although most manufacturers aim for a turnover of 60-90 days.
Conclusion
Managing raw material inventory is a crucial aspect of manufacturing operations. It ensures that you have the necessary material on hand to meet production demands while minimizing excess stock and associated costs.
By implementing effective inventory management practices, such as accurately calculating your raw material inventory needs and regularly monitoring stock levels, you can streamline your manufacturing process and improve overall efficiency. Remember, having too little or too much raw material can disrupt production and lead to costly delays.
So, take the time to carefully analyze your inventory requirements and develop a robust strategy for managing your raw material. With proper inventory management in place, you can optimize your manufacturing operations and set your business up for success. Read More – Qodenext.
