Raw Materials Inventory: Everything You Need to Know in 2023

In this article, we explore what raw materials inventory is and why it’s crucial to keep track of them. We will also walk you through our step-by-step framework to help you monitor and manage them effectively, with real-world examples. Read on to learn more.

What Is Raw Materials Inventory? 

Raw materials inventory refers to the initial inputs or resources a company holds before they are processed into finished goods. These materials are essential components that are transformed during the manufacturing process to produce the end product.

Example: Solar Tech Industries stores 4,000 tons of high-grade silicon, a raw material crucial for their solar panel production line.

Importance of Raw Material Inventory Management

Raw materials inventory management is foundational to the successful operation of manufacturing and production businesses. Here are some key reasons why:

Cost Management: Tracking raw materials inventory helps businesses monitor and control expenses, ensuring they aren't overstocking or tying up excess capital.

Supply Chain Efficiency: Accurate inventory levels facilitate smoother supply chain operations, reducing lead times and preventing production halts.

Waste Reduction: By monitoring raw materials, businesses can identify and minimize spoilage, deterioration, or obsolescence.

Financial Reporting: Accurate inventory valuations are essential for financial statements, impacting balance sheets and profit & loss accounts.

Demand Forecasting: Understanding past usage patterns of raw materials can inform future purchasing decisions, aligning inventory with market demand.

Risk Mitigation: Regular inventory checks can help identify issues like theft, damage, or supply disruptions early, allowing for timely corrective actions.

8-Step Framework to Manage Raw Materials Inventory More Effectively 

Effective management of raw materials inventory is crucial to optimize production, control costs, and maintain supply chain efficiency.

To do this, simply follow our 8-step framework below: 

Step 1: Understand Your Raw Materials Consumption Rate

Identify the rate at which each raw material is used in production to determine reorder points.

Example: "Crafty Ceramics Inc." calculates they utilize 50 pounds of clay daily. Hence, in a month, they consume about 1,500 pounds.

Step 2: Calculate Economic Order Quantity (EOQ)

Use the EOQ formula to determine the ideal order size for each raw material. The formula is:

EOQ = Square Root of (2 x Annual Demand x Order Cost) divided by Holding Cost per Unit per Year.

Example: For "Stee Frame Constructions" with an annual demand of 2,400 beams, an order cost of $50, and a holding cost of $5 per beam per year, their EOQ would be the square root of (2 x 2,400 x $50) divided by $5, which is approximately 138 beams.

Step 3: Conduct Regular Physical Audits

Physically count raw materials periodically to ensure the actual inventory aligns with recorded numbers.

Example: "Paper Print Publishers" performs monthly spot checks, recently catching a discrepancy of 500 reams of paper, preventing a potential production halt.

Step 4: Implement a First-In, First-Out (FIFO) Approach

Use older stock first to reduce the risk of spoilage or material obsolescence.

Example: "Fresh Fruit Juices" always processes fruits that arrived earlier, ensuring their juices maintain consistent freshness.

Step 5: Prioritize Raw Materials by Importance

Categorize materials based on their importance to production, enabling focused monitoring on critical items.

Example: "ElectroTech Industries" categorizes microchips as 'A' items (high priority) due to their high cost and significant role in product assembly.

Step 6: Collaborate Closely with Suppliers

Foster close relationships to understand lead times, potential disruptions, and negotiate volume discounts.

Example: "Wood Works Ltd." collaborates with their lumber supplier, obtaining a two-week heads-up for any potential supply delays.

Step 7: Invest in Advanced Forecasting Techniques

Use techniques like trend analysis or regression to forecast future raw material needs based on sales and production trends.

Example: "Solar Shine Panels" uses trend analysis, predicting a 20% increase in silicon demand next quarter due to rising solar panel orders.

Step 8: Monitor External Factors Impacting Raw Materials

Stay informed about factors like global production, politics, or natural disasters that might affect raw material availability or cost.

Example: "Cocoa Brew Chocolates" keeps an eye on global cocoa production. After detecting potential shortages in West Africa, they diversified their suppliers early.

Example

ClearVue Glasses Inc., a leading eyewear manufacturer, is looking to optimize its raw materials inventory, as they've faced both stockouts and overstock situations in the past year. 

They decided to follow our 8-step framework: 

Step 1: Understand Your Raw Materials Consumption Rate

ClearVue calculates that they use 100 pounds of plastic resin daily for their frames, totaling 36,500 pounds annually.

Step 2: Calculate Economic Order Quantity (EOQ)

Using the EOQ formula:

EOQ = Square Root of (2 x Annual Demand x Order Cost) divided by Holding Cost per Unit per Year.

ClearVue, with an annual demand of 36,500 pounds, an order cost of $100, and a holding cost of $1 per pound per year, finds their EOQ to be approximately 2,701.85 pounds.

Step 3: Conduct Regular Physical Audits

In their quarterly audit, ClearVue identifies a discrepancy of 50 pounds of resin, allowing them to adjust their records and order promptly.

Step 4: Implement a First-In, First-Out (FIFO) Approach

ClearVue ensures they use their oldest stock of plastic resin first, maintaining the quality of their glasses and reducing waste.

Step 5: Prioritize Raw Materials by Importance

The company categorizes their high-quality lens material as a top-priority item due to its role in customer satisfaction and overall product quality.

Step 6: Collaborate Closely with Suppliers

ClearVue collaborates with their primary resin supplier, ensuring they're informed about any potential disruptions, and they negotiate a 5% discount on bulk orders above 500 pounds.

Step 7: Invest in Advanced Forecasting Techniques

Using trend analysis, ClearVue predicts a 15% increase in demand for their glasses in the upcoming summer months, translating to an increased need for resin.

Step 8: Monitor External Factors Impacting Raw Materials

ClearVue stays updated about global plastic production trends. After identifying a potential price hike due to petroleum market fluctuations, they locked in a contract with their supplier at the current rate for the next six months.

We hope you now have a better understanding of what raw materials inventory is and how to manage them more effectively.