In this article, we explore 20 of the most common inventory terms that you should be aware of. We also share examples for better illustration of each term. Read on to learn more.
20 Common Inventory Terms
Here are some common inventory terms every business should know. Let’s explore each below:
Definition: A detailed list of goods, articles, and assets, either raw materials or finished goods, that a business possesses at any given time.
Example: The local grocery store performs a weekly inventory check to ensure they restock necessary items. Large companies might have thousands of items listed in their inventory system.
Stock Keeping Unit (SKU)
Definition: A unique identification code that helps retailers specify the price, product options, and manufacturer of the merchandise.
Example: When Jane wanted a specific model of a smartphone, she provided the salesperson with the SKU number. This ensured she received the exact product she desired.
Definition: The time interval between the initiation and completion of a process, such as the period from the placement of an order to its receipt.
Example: If a manufacturer has a lead time of 14 days for a product, customers would expect delivery within that timeframe. Retailers might order in advance considering this lead time to prevent stockouts.
Definition: A situation in which an item is not available for sale or use as required.
Example: During the holiday season, popular toys often experience stockouts. Retailers try to forecast demand to prevent these situations and satisfy their customers.
Definition: Additional quantities of an item held in the inventory to reduce the risk of stockout due to uncertainties in supply and demand.
Example: To account for unexpected surges in demand or delays in shipment, a store might keep a safety stock of best-selling items. This ensures that they can cater to customer needs even in unpredictable situations.
Just-In-Time (JIT) Inventory
Definition: An inventory strategy where materials are only ordered and received as they are needed in the production process, thereby reducing inventory costs.
Example: A car manufacturer using JIT inventory might only order parts when a car is set to be assembled, rather than stockpiling them. This method reduces storage costs but requires precise coordination.
Definition: A regular and recurring process where a subset of inventory is counted on a specific day or days.
Example: Instead of counting their entire warehouse inventory at the end of the year, a business may use cycle counting to audit certain sections monthly. This spreads out the workload and can help identify discrepancies more quickly.
Definition: The total cost of holding an item in stock, which includes storage costs, insurance, losses due to obsolescence, and more.
Example: If a product has high carrying costs, a company might reduce its stock levels to save money. Alternatively, they might decide to increase turnover rates for such products.
Economic Order Quantity (EOQ)
Definition: The ideal order quantity a company should purchase to minimize its inventory costs, considering carrying costs and order costs.
Example: Using the EOQ formula, a retailer determines that ordering 500 units of a product at a time is the most cost-effective quantity. This helps in balancing ordering costs with carrying costs.
Definition: The inventory level at which a new order should be placed to replenish stock before it runs out.
Example: If a coffee shop knows that they consume 50 bags of coffee beans a week and the lead time for delivery is one week, they might set their reorder point at 50 bags to ensure continuous availability. If they also account for safety stock, the reorder point might be slightly higher.
Perpetual Inventory System
Definition: A method of accounting for inventory that records the sale or purchase of inventory immediately through the use of computerized point-of-sale systems and enterprise asset management software.
Example: When a customer buys a shirt from a store using a perpetual inventory system, the system instantly updates the number of shirts in stock. This real-time tracking helps retailers maintain accurate inventory records.
Definition: The process of counting by hand the entire stock a business holds, typically done annually or biannually.
Example: Every January, the bookstore closes for a day to conduct its physical inventory. All employees participate to ensure every book on the shelves is accounted for.
Days Sales of Inventory (DSI)
Definition: A financial metric that shows the average number of days a company takes to turn its inventory into sales.
Example: If a company has a DSI of 40 days, it means, on average, the inventory on hand is sold and replaced every 40 days. This helps businesses understand how quickly their products move.
Definition: Inventory items that have never been sold or used, usually due to being obsolete, outdated, or no longer in demand.
Example: The electronics store had several old models of phones as dead stock. They planned a clearance sale to move this unsold inventory.
Definition: The number of times a company's inventory is sold and replaced over a given period.
Example: If a toy store has an inventory turnover rate of 5 times per year, it means the entire inventory is sold and restocked 5 times in one year. A higher turnover rate indicates efficient sales and inventory management.
Definition: An order for an item that cannot be filled at the current time due to a lack of available inventory. Customers can choose to wait for the item to be restocked or cancel the order.
Example: The latest video game console was in high demand, and the store ran out of stock. Customers had the option to backorder it and receive it once more units were available.
Definition: The loss of inventory items due to factors like theft, damage, miscounting, or supplier fraud.
Example: At year-end, the retail store identified a 2% inventory shrinkage, which means they lost 2% of their products from theft, damages, or other reasons. They decided to implement stricter security measures to reduce this in the coming year.
FIFO (First-In, First-Out)
Definition: An inventory valuation method where the oldest inventory items are recorded as sold first, regardless of the actual item sold.
Example: If a bakery uses the FIFO method and bakes bread on Monday and Tuesday, any sales on Wednesday would be recorded against Monday's stock first. This approach helps in managing perishable goods effectively.
LIFO (Last-In, First-Out)
Definition: An inventory valuation method where the newest inventory items are recorded as sold first, regardless of the actual item sold.
Example: A company selling electronic devices might use the LIFO method, meaning the latest received devices would be sold first in the accounting books. This method can have tax advantages in some scenarios with rising inventory costs.
Definition: An inventory categorization method that divides inventory into three categories based on its value and importance.
Example: A store categorizes its inventory into A, B, and C groups. 'A' items are high-value products with low sales frequency, 'B' items are medium value and medium frequency, and 'C' items are low-value with high sales frequency. This helps prioritize inventory management efforts.
We hope our article has given you a better understanding of some common inventory terms and their value for your business.