Accurate definition of keywords that inventory managers must know
Are you new to inventory management? Do you ever feel lost when it comes to managing your inventory? Having a solid foundation of the basic terminology should make it much easier to understand the concept of inventory management. We’ll introduce some of the key inventory management terms in this article for systematic and efficient inventory management.
The origin of the word “inventory” can be traced back to the Old French ‘inventoire’ a “detailed list of goods, a catalogue” (15c., Modern French ‘inventaire’), and also from the alteration of Late Latin ‘inventarium’, a "list of what is found." Now that we’ve covered the origin of the word, what can we call “inventory”? What is the difference between stocks and inventory?
Often, the words stock and inventory are used interchangeably, but they refer to different things.
Stock refers to the goods or materials that a business holds for sale or uses in its operations. It can refer to finished products, raw materials, or work-in-progress items that are being produced. In general, the stock is the term used for items that have been purchased or manufactured but have not yet been sold or used.
Inventory, on the other hand, is a broader term that includes all of the goods and materials that a business holds, regardless of whether they have been purchased, manufactured, or used. Inventory includes stock, but it also includes items that have been used in production or that are being held for other purposes, such as spare parts or office supplies.
In summary, the stock is a subset of inventory that refers specifically to items that are being held for sale or use in operations, while inventory is a more general term that encompasses all of the goods and materials that a business holds.
Can we call all the items in the warehouse ‘inventory’? It is important to note that not all items in the warehouse serve the same purpose. Depending on why and for what purpose the goods are in the warehouse, you can further divide the inventory type into 'safety stock', 'reserve stock', 'cycle inventory', and 'stock in transit'. Inventory managers need to be aware of the existence of these different types of inventory, and manage them separately by their type.
'Safety stock' tells you the minimum quantity of stock you need to have, and it can also be called a 'buffer stock'. It is a type of stock that helps you cope with various uncertainties that may arise while running a business. Imagine a product that normally sold an average of 10 units a day suddenly started selling 100 units a day! If you only have 10 units as expected in stock, you won't be able to meet the sudden rise in demand. 'Safety stock' plays an important role in preventing losses in times of uncertainty such as an unexpected, rapid rise in demand. It also helps businesses keep their promises to their customers.
'Reserve stock' signifies stock prepared in advance in anticipation of high demand. It's often referred to as ‘stockpile,’ a stock that's being saved for those ‘just-in-case’ moments. Imagine how companies that produce and sell novelty holiday plates would set up production plans ahead of holidays such as New Year's Day, Christmas, or Thanksgiving. They anticipate that the special plates will be sold in larger quantities either as holiday gifts or for decorating tables for family gatherings and intentionally increase the amount of stock. This type of stock is ‘reserve stock'. Accordingly, companies that sell products with increasing demand over time should be prepared with ‘reserve stock’ to prevent foreseeable issues with sales. In addition, ‘reserve stock’ can help smooth out any inconsistencies that may occur due to production schedule interruptions from inspections or exchange and/or replacement of parts of the machines.
'Cycle inventory' refers to inventory that is stored in the warehouse according to a set cycle. ‘Cycle inventory’ is all about putting a certain amount of items in the warehouse on a regular basis, either once every three days, once a week, or once a month. Technically, businesses can order or produce just the amount that they need, so why would you need to have 'cycle inventory'? The key here is to focus on the economics behind such activities. A lot of management manpower is involved in checking the warehouse every hour or every day for low-stock items. It wouldn’t be very economical to start up production facilities every time inventory is low, either. However, optimizing ordering and production times through ‘cycle inventory’ can reduce many of these costs. ‘Lot size stock’ is also used synonymously from the words ‘Lot Size’, which refers to the unit in which production is performed.
Inventory typically refers to the items in the warehouse, but there are also items in the inventory that are not in the warehouse. 'Stock in transit' is the inventory that has already been purchased, but has not yet arrived at the warehouse. Terms such as 'moving stock' or 'in-transit inventory' are also used commonly. And as inventory is transported to the destination, it can be called 'pipeline inventory'. Take, for example, a company that imports and sells goods from abroad that may need a procurement period that is longer than usual. Because the transport time is longer for this company, their 'stock in transit' is bound to increase. For effective inventory management, these types of ‘stock in transit' definitely should not be overlooked.
Additionally, in order to prepare for demand during the peak seasons, depending on the industry, 'seasonal inventory' helps with the advance purchase or production of products during the off-season. There is also a special kind of inventory referred to as ‘speculative stock’ where purchases or productions occur regardless of demand in preparation for strikes or material price hikes. If you have inventory that is stored in the warehouse for a long time and lost due to theft, deterioration, or damage. These would be referred to as ‘sunken stock'. If you manage expensive products or perishables, it would be in your best interest to try to minimize these types of inventory.
What are ‘inventory holding costs’ and ‘stockout costs’?
Inventory management matters because of the higher cost associated with it. Knowing the types of inventory management costs will give you a holistic view of the areas where you can reduce costs.
For example, if you’re a distributor that runs your business by selling procured goods, you have to go through the process of purchasing the goods. The cost incurred in the process of procurement is called ‘purchase cost'. This not only includes the price of the product, but also takes into account labor costs, transportation costs, unloading costs, and customs clearance costs.
If you manage a company that produces and sells products directly, ‘preparation cost' is incurred. 'Preparation cost' refers to the incidental costs required to produce the product. This type of cost can range anywhere from; costs for replacing production equipment, idle costs incurred when production equipment is not in use, and labor costs for staff preparing for production.
That same company mentioned above can also have 'inventory holding cost' for inventory that has been created through purchasing and production, which essentially is the cost of maintaining inventory. 'Inventory holding cost' can be classified into three big categories; 'capital cost', 'storage cost', 'and risk cost', and 'opportunity cost'. These costs can be characterized by the fact that the more stock there is, the higher the cost.
• Storage cost: Building rent, building insurance, building repair costs, cooling/heating costs, taxes, etc.
• Risk cost: Loss of inventory due to theft, deterioration, damage, etc., property insurance, etc.
• Opportunity cost: the funds locked up in inventory that could be used to invest in the stock market.
'Lack of inventory cost' is the opportunity cost incurred by not securing the 'safety stock' or 'preliminary stock'. Although it is not an actual payment of a cost, it is a profit loss resulting from lost sales opportunities. 'Stockout cost' can also be used interchangeably to describe the same situation. One of the damages caused by inventory shortages can be a loss of reputation, which may have irreparable consequences that cannot be repaired with money. Another type of stockout costs can include ancillary or service costs such as free gifts provided to customers to ‘make up’ the business’s failure to keep delivery promises.
We’ve explored the different types of inventory and the costs involved in managing each of them. Hopefully, this overview helped demystify some of the inventory management terminologies. Excessive inventory drives up costs, and lack of inventory, or being ‘out-of-stock’ can lead to lost customers. In summary, it is important to properly maintain inventory through demand forecasting and prevent out-of-stock situations in advance through steady inventory management. If you are new to inventory management, start with BoxHero.
With BoxHero, inventory management will be a breeze!