Inventory management is the process companies use to order, receive, account for and manage the various products sold to consumers. Business owners and managers focus on this activity because inventory typically represents the second largest expenditure in a company behind payroll. Policies and procedures help companies actively manage the different products in their facilities. While standard policies and procedures exist for inventory management, owners and managers have some latitude to develop standards for their own companies.
Procurement is the purchasing process individuals must use to order and receive inventory. Companies typically require individuals to have a purchase order with a manager’s authorization prior to ordering inventory. A procurement manager is responsible for reviewing the purchase order to ensure it includes authorization and other information relating to the cost of items purchased. While larger organizations can hire individuals to work in the procurement department, smaller companies often have the business owner perform this function.
Valuing inventory is the policy in which inventory sells first and is removed from the accounting ledger. Methods include first-in, first-out (FIFO), last-in, first-out (LIFO) and the weighted average method. FIFO requires companies to sell older inventory first, leaving more expensive inventory in the general ledger and increasing the company’s gross profit during an accounting period. LIFO is the opposite of FIFO; therefore it has the opposite effects in the accounting ledger. The weighted average method does not require older inventory to be sold first as inventory costs are recalculated each time the company purchases inventory.
An inventory accounting system is the specific procedures a company uses to update its accounting ledger. The two types of systems are periodic and perpetual. Periodic systems start with an opening balance and only record purchases, sales or adjustments on a monthly, quarterly or annual basis. The perpetual system starts with the opening inventory balance and updates inventory after each purchase, sales or inventory adjustment. Companies create their policies depending on their business models.
Physical controls relate to how a company stores and counts inventory items. Storage is important because companies must safeguard their inventory against loss, theft and employee abuse. This can include limiting access, locking up valuable products and using tracking devices on products. Business owners and managers must also use periodic counts to verify the number of items on hand. Cycle counts—counting a specific number of items each day or week—and annual inventory counts are the most common physical counting methods in the business environment.