High-level Inventory ManagementIt seems that around 1880 there was a change in manufacturing practice from companies with relatively homogeneous lines of products to horizontally integrated companies with unprecedented diversity in processes and products. Those companies (especially in metalworking) attempted to achieve success through economies of scope - the gains of jointly producing two or more products in one facility. The managers now needed information on the effect of product-mix decisions on overall profits and therefore needed accurate product-cost information. A variety of attempts to achieve this were unsuccessful due to the huge overhead of the information processing of the time. However, the burgeoning need for financial reporting after 1900 created unavoidable pressure for financial accounting of stock and the management need to cost manage products became overshadowed. In particular, it was the need for audited accounts that sealed the fate of managerial cost accounting. The dominance of financial reporting accounting over management accounting remains to this day with few exceptions, and the financial reporting definitions of 'cost' have distorted effective management 'cost' accounting since that time. This is particularly true of inventory.
Hence, high-level financial inventory has these two basic formulas, which relate to the accounting period:
- Cost of Beginning Inventory at the start of the period + inventory purchases within the period + cost of production within the period = cost of goods available
- Cost of goods available − cost of ending inventory at the end of the period = cost of goods sold
Manufacturing management is more interested in inventory turnover ratio or average days to sell inventory since it tells them something about relative inventory levels.
- Inventory turnover ratio (also known as inventory turns) = cost of goods sold / Average Inventory = Cost of Goods Sold / ((Beginning Inventory + Ending Inventory) / 2)
- Average Days to Sell Inventory = Number of Days a Year / Inventory Turnover Ratio = 365 days a year / Inventory Turnover Ratio
While these accounting measures of inventory are very useful because of their simplicity, they are also fraught with the danger of their own assumptions. There are, in fact, so many things that can vary hidden under this appearance of simplicity that a variety of 'adjusting' assumptions may be used. These include:
- Specific Identification
- Weighted Average Cost
- Moving-Average Cost
- FIFO and LIFO.
Business models, including Just in Time (JIT) Inventory, Vendor Managed Inventory (VMI) and Customer Managed Inventory (CMI), attempt to minimize on-hand inventory and increase inventory turns. VMI and CMI have gained considerable attention due to the success of third-party vendors who offer added expertise and knowledge that organizations may not possess