Inventory is the backbone of any business – whether you run a retail business, a manufacturing unit, or an online brand. Managing it effectively ensures you never miss a sale, overspend on storage, or run out of stock. There are many different sorts of inventory, and this article explains how to keep track of them. You can receive the greatest return on investment (ROI) for your organization if you know the finest inventory methods and analysis methodologies.
Let’s dive in.
What Is Inventory? Everything a Business Owner Needs to Know
Inventory refers to all goods, raw materials, and finished products that a business holds for sale, production, or use. It is recorded as a current asset on the balance sheet.
Inventory management is the backbone of any product-based business. Whether you run a kirana store, manufacturing unit, or e-commerce brand, understanding inventory directly impacts your profitability and cash flow. Getting it wrong means either too much capital locked in stock or empty shelves when customers come calling. This guide breaks down the four main inventory types, the valuation methods Indian businesses can legally use, and why this matters for your working capital.
Inventory is valued using a costing method applied consistently to all stock. Under Indian Accounting Standards (Ind AS 2), businesses can use FIFO (First In, First Out) or Weighted Average Cost; LIFO is not permitted. Inventory is recorded on the balance sheet at the lower of cost or net realisable value.
Also Read: How To Scale The Retail Business Using Inventory Loans
Types of Inventories
Here are the different types of inventories businesses use depending on the nature of their business.
Anticipation Inventory
Such stockpiles are built up by corporations in anticipation of future demand for a particular product. A major holiday, promotion, festival, or even a strike causes them to build up.
Example: Companies that make winter-themed cosmetics ramp up manufacturing in preparation for the cold weather.
Safety Stock or Fluctuation Inventory
In the event of supply and demand uncertainty or a long lead time, inventory is held. A stock out might occur if the lead time is longer or the demand is more than expected. Safety stock is kept on hand just in case. Preventing any interruptions in production or delivery to customers is the primary objective. It’s also known as “reserve or buffer stock.”
Example: Jewelers stock up on gold before Diwali or wedding season as a precautionary measure because gold is a highly volatile commodity.
Lot Size Inventory
Items purchased or manufactured in more significant numbers than necessary for the current market are known as lot-size inventory. It is possible to buy this inventory to save money on inventory, shipping, setup, and clerical costs, as well as when making or buying products at the same rate is not feasible. Cycle stock is the name given to this sort of stock. Some of the stock is depleted as more orders are shipped.
Example: Before the winter season, businesses buy a lot of winter wear.
Repair, Operating, and Maintenance Supplies
The products that make up operational, repair, and maintenance supplies aren’t immediately tied to any of their actual products; instead, they help keep the company running smoothly.
Example: Generally, this includes cleaning materials such as mops and brushes and other equipment used to maintain machines.
Raw Materials Inventory
Using this inventory, the corporation creates finished products sold to customers. Only businesses engaged in producing goods can make use of this inventory. Once the product is finished, it’s impossible to tell which ones are.
Example: Shampoo manufacturers get their basic materials from the oil utilized in their products.
Components inventory
Components are somewhat comparable to raw materials, yet they may be identified in the finished goods. The only businesses that can use this inventory are those engaged in product production.
Example: Applies to the clothing used in the production of finished outfits.
Also Read: How Does Working Capital Help In Keeping Your Business Stay Agile?
Work In Progress (WIP) Inventory
Parts, raw materials, administration, workforce, and other packing supplies are all included in this inventory.
Example: WIP inventory can be thought of as the various motorcycle components that are utilized to complete its structure at a workspace.
Finished Goods Inventory
Ready-to-sell products make up the bulk of this stockroom’s contents. Manufacturers and distributors can both use this inventory.
Example: Tobacco products that have been finished and refined are known as finished goods inventories.
Packing and Packaging Materials Inventory
For packing, this inventory is needed. It protects the product from environmental degradation or harm. It is also useful for labeling and is often well-decorated. Large cartons for bulk orders are also included.
Example: Large cartons pack snacks like crackers, cookies, and wafers.
Decoupling Inventory
The WIP (work-in-progress) inventory is kept at the manufacturing line stations to avoid work stoppages. This inventory is useful if various machinery is used to process the items. The only purpose for this is for production.
Example: Even if the natural flowers aren’t supplied, a venue’s event management business will have artificial flowers on hand to beautify the space in their absence. Faux flowers are decoupling inventory in this case.
Service Inventory
Companies that provide services instead of products are the focus of this discussion. A service inventory relates to the services a company can provide at any one time. Two hundred fifty clients can be served in 10 days by a sauna with five treatment rooms.
Example: On any given day, a hotel with 100 rooms can accommodate 100 guests. Here, the 100 rooms are the service inventory.
Transit Inventory
This inventory keeps track of the commodities moving between distribution hubs, warehouses, and manufacturers. Moving from one facility to another can take several months. It is a sort of inventory management that is known as pipeline inventory.
Example: Shipping businesses and online retailers provide excellent models of transit inventory in action.
Theoretical Inventory
This inventory aims to keep track of stock that can be fulfilled in the shortest amount of time feasible, without the need for additional waiting time.
Example: If a hotel estimates that it will spend 10% on room cleaning but discovers that it has spent 15%, it is overspending. There is an additional 5% of theoretical inventory in this case.
Excess Inventory
Inventory that has not been sold or is made up of raw materials but is still being held by a corporation is called surplus inventory. This also includes any inventory that isn’t needed right away but can be depleted later.
Example: Businesses selling umbrellas after the rainy season must store their products until the next rainy season. So, this stock has excess inventory.
Inventory valuation methods
How you assign costs to inventory affects your profit figures, tax liability, and balance sheet. Indian accounting standards permit two main methods.
FIFO (First in, first out)
FIFO assumes the oldest inventory is sold first. If you bought 100 units at INR 50 each, then another 100 at INR 60, selling 120 units means your cost of goods sold (COGS) uses the INR 50 batch first.
Example: 100 units × INR 50 = INR 5,000, plus 20 units × INR 60 = INR 1,200. Total COGS = INR 6,200. Your closing inventory (80 units) is valued at the newer INR 60 price.
During inflation, FIFO shows higher profits because older, cheaper costs hit your COGS while newer, pricier stock stays on the books.
LIFO (Last in, first out)
LIFO assumes the newest inventory is sold first. Using the same example, selling 120 units would cost 100 × INR 60 = INR 6,000, plus 20 × INR 50 = INR 1,000. Total COGS = INR 7,000.
Important for Indian businesses: LIFO is not permitted under Ind AS 2 or for computing taxable income under ICDS-II. If your business follows Indian Accounting Standards, you cannot use LIFO for financial reporting or tax filings.
Weighted average cost
This method calculates the average cost of all inventory available during the period. Using our example: (100 × INR 50 + 100 × INR 60) ÷ 200 = INR 55 per unit. Selling 120 units gives COGS of INR 6,600.
Weighted average smooths out price fluctuations and is simpler to apply when inventory items are interchangeable.
| Method | Basis | Impact on profit (rising prices) | Permitted under Ind AS 2? |
|---|---|---|---|
| FIFO | Oldest costs to COGS first | Higher reported profit | Yes |
| LIFO | Newest costs to COGS first | Lower reported profit | No |
| Weighted average | Average cost across all units | Moderate profit | Yes |
Why inventory management matters for MSMEs
Poor inventory control hits small businesses harder than large corporations. You have less margin for error and tighter cash reserves.
Overstocking ties up working capital. Every rupee sitting in slow-moving stock is a rupee you cannot use for rent, salaries, or growth. Carrying costs (storage, insurance, potential spoilage) can run 20% to 30% of inventory value annually.
Understocking costs you sales. Empty shelves mean lost customers, some of whom may not return. Stockouts can cost 4% to 10% of potential sales value, according to industry research.
Seasonal businesses face amplified risks. A retailer stocking up for Diwali needs capital months before sales arrive. A manufacturer supplying wedding season orders must fund raw materials well in advance.
Inventory financing from lending partners through platforms like Indifi helps businesses fund stock purchases without straining cash flow. Instead of depleting reserves or missing bulk-order discounts, you can access working capital matched to your inventory cycle.
Need capital to stock up before peak season? Indifi connects you with lending partners offering working capital loans with disbursal in up to 48 hours. Check your eligibility today.
Wrapping Up
Understanding the inventory allows one to maintain track of supplies and inventories. As a result, the company will have no trouble locating what it requires and when. It ensures that the appropriate amount of merchandise is purchased at the appropriate time. This operation benefits from processing inventory levels, preventing out-of-stocks, and lowering storage costs.
FAQs
1. What is the meaning of inventory in business?
Inventory refers to all goods a business holds for sale, production inputs, or operational use. It appears as a current asset on the balance sheet and converts to cost of goods sold when items are sold to customers.
2. What are the 4 types of inventory?
The four main types are raw materials (production inputs), work-in-progress (partially completed goods), finished goods (ready for sale), and MRO supplies (maintenance and operational items that support business functions).
3. What are FIFO and LIFO?
FIFO (First In, First Out) assumes the oldest stock is sold first. LIFO (Last In, First Out) assumes the newest stock is sold first. Under Indian accounting standards (Ind AS 2), only FIFO and weighted average are permitted.
4. How is inventory recorded in accounting?
Inventory is recorded as a current asset on the balance sheet at the lower of cost or net realisable value. When sold, the cost moves to the income statement as cost of goods sold, reducing inventory value.
5. What is the difference between inventory and stock?
In practice, the terms are often used interchangeably. Technically, stock may refer specifically to finished goods for sale, while inventory covers all categories, including raw materials, WIP, and MRO supplies.
6. How can small businesses manage inventory efficiently?
Use inventory management software or spreadsheets to track stock levels. Set reorder points for fast-moving items. Conduct regular physical counts. Match purchasing to actual demand patterns rather than guesswork.