Inventories constitute significant assets for most companies, especially those involved in international trade or relying on warehouses to run their operations. The fact remains, a manufacturing or non-manufacturing firm stills needs to set appropriate inventory management procedures. Establishing these policies clearly signals top leadership's willingness to rein waste in production processes and prevent inventory theft.
Inventories are short-term corporate assets, which a company usually purchases (for resale) or manufactures in its production facilities. As such, a company's inventories can be raw materials and in-house manufactured goods, such as semi-finished goods and completely finished products. Inventories are considered short-term assets, as they serve in operating activities for less than 12 months. Companies do not count inventories in their financial asset reports. Financial assets are non-physical resources that are quickly convertible into cash. Monetary assets include securities and other investment instruments, such as bonds, stocks and options.
A company distinguishes three types of inventories in its operations. Raw materials are commodities that production managers use to manufacture other products. These commodities are usually agricultural products or industrial matter and include copper, iron, corn, coffee and aluminum. Semi-finished products are items that are already in the production chain but have not yet reached final manufacturing stages. Completely finished products are items that a company can sell in the marketplace once quality reviews are satisfactory.
Even though inventories are not financial assets, they are an important funding source for companies. Accordingly, organizations consider merchandise as a source of liquidity, since goods can easily be converted into cash. In fact, companies put into place adequate controls, procedures and methodologies to preserve the physical integrity of inventories. Controls are stipulations that top leadership establishes to prevent losses resulting from theft, waste and inaccurate recording.
To record inventory purchases, a corporate bookkeeper debits the inventories account and credits the cash or vendor payables account. The bookkeeper credits the vendor payables account if the purchase is a credit transaction. By debiting inventories — an asset account — the corporate bookkeeper increases the account balance. When the company pays its vendor, the accounting entries are: credit the cash account and debit the vendor payables account. The accounting concepts of credit and debit are distinct from banking terms. As such, crediting cash — an asset account — means reducing corporate funds.
A company reports inventories in its balance sheet, also known as a statement of financial position or statement of financial condition. In addition to merchandise, a balance sheet indicates other corporate assets, such as accounts receivable, real estate, equipment and machinery. A statement of financial position also features a company's debts and equity capital.