Definition of Inventory
Inventory is a very significant current asset for retailers, distributors, and manufacturers. Inventory serves as a buffer between 1) a company's sales of goods, and 2) its purchases or production of goods.
Companies strive to find the proper amount of inventory so that it can meet the fluctuating demand of its customers, avoid disruptions in production, and minimize holding costs.
Since the costs of the items purchased or produced are likely to change (especially with inflation), companies must elect a cost flow assumption for valuing its inventory and its cost of goods sold. In the U.S. the common cost flow assumptions are FIFO, LIFO, and average.
A company's cost of inventory is related to the company's cost of goods sold that is reported on the company's income statement.
Examples of Inventories
Retailers and distributors are likely to have one type of inventory, namely merchandise.
Manufacturers will have three or four categories of inventories:
- Raw materials
- Finished goods
- Manufacturing and packaging supplies
Manufacturers are required to report the amounts of each inventory category on its balance sheet or in the notes to the financial statements.