Raw Materials Inventory: The Ultimate Guide

Rohit Rajpal

Senior Writer

raw materials inventory guide

Inventory is just money, sitting around in another formRhonda Abrams, USA Today’s Columnist

Every manufacturing process begins with raw materials. These basic components form the foundation of production across industries. Managing raw materials inventory helps enhance production efficiency and reduce overall costs. It impacts production schedules, supplier relationships, and overall financial health.

leftarrow imageLooking for Inventory Software? Check out SoftwareSuggest’s list of the best inventory planning software solutions.

Businesses that master raw materials management can reduce waste, minimize stockouts, and optimize cash flow. Effective inventory strategies also help companies adapt to market fluctuations and meet customer demands more reliably.

Let’s understand what raw material inventory is, its importance, challenges, and best practices for managing it effectively.

What is Raw Material Inventory?

Raw material inventory refers to the stock of unprocessed resources that are used in production processes. These materials undergo various stages of transformation throughout the manufacturing journey.

Direct materials are the primary components that become a part of the final product. For example, in furniture manufacturing, wood would be a direct material. It’s directly incorporated into the finished product – a chair or table. Similarly, in the oil industry, crude oil, natural gas, and various chemicals serve as direct materials.

raw materials inventory example by softwaresuggest

Indirect materials, on the other hand, are used in the production process but don’t become part of the final product. Examples include lubricants used to maintain machinery, cleaning supplies for the factory floor, or protective gear for workers. Although these items don’t end up in the final product, they are important in the manufacturing process and require meticulous oversight as part of the broader raw material inventory system.

Why is Managing Raw Material Inventory Important?

Raw material stock management is crucial for several reasons. Firstly, it ensures production continuity by preventing stockouts that could halt manufacturing processes. Effective management also helps optimize cash flow by balancing the need for sufficient materials with the cost of storing excess inventory. It enables businesses to swiftly adapt to market shifts and sustain competitive price points.

Moreover, effective management of raw materials can substantially decrease waste and enhance product quality standards. By tracking inventory accurately, businesses can identify and address issues like material degradation or obsolescence before they impact product quality. It also supports better supplier relationships through more accurate forecasting and ordering.

Accounting for Raw Materials Inventory Management

Accurate accounting of raw materials inventory is crucial for both financial reporting and operational decision-making. This involves meticulously tracking the lifecycle of materials from purchase to storage and finally to usage in production.

To value their raw materials inventory, companies often employ methods such as First-In-First-Out (FIFO) or Last-In-First-Out (LIFO). In FIFO, the oldest inventory items are used first, while in LIFO, the most recently bought inventory items are used first. These valuation techniques determine how costs are assigned to used materials and remaining inventory, which in turn affects the cost of goods sold and the reported inventory value.

FIFO vs LIFO
FIFO LIFO
Offload the first items added to inventoryItems added last are the first to go
Works well for selling perishable itemsWorks well for selling homogeneous products
Widely usedUsed less often

Beyond basic valuation, companies must also account for various factors that can impact inventory value. These include obsolescence, damage, or changes in market value, all of which may necessitate inventory write-downs or adjustments that can significantly influence financial statements. Moreover, proper accounting practices help identify slow-moving inventory, optimize reorder points, and improve overall inventory turnover rates.

How to Calculate Raw Materials Inventory?

Now that you understand the importance of raw material inventory management, here’s how you can calculate raw materials inventory value.

Raw Material Inventory = Beginning Raw Material Inventory + Raw Material Purchases – Raw Materials Used

Let’s say a furniture company starts the month with $50,000 worth of wood (beginning inventory). During the month, they purchase an additional $30,000 of wood and use $60,000 worth in production.

$50,000 (Beginning) + $30,000 (Purchases) – $60,000 (Used) = $20,000 (Raw Material Inventory)

This means that the company has $20,000 worth of raw materials (wood) in inventory at the end of the month.

How to Calculate Raw Material Inventory Turnover?

Calculating raw material inventory is just the first step. To truly gauge the efficiency of your inventory management, you need to understand the concept of inventory turnover. Here’s the raw material inventory turnover formula.

Raw Material Inventory Turnover = Cost of Raw Materials Used / Average Raw Material Inventory

Using the same furniture company, let’s assume the cost of raw materials used for the year is $720,000. The average raw material inventory is calculated by adding the beginning and ending inventory values and dividing by 2.

  • Beginning raw materials inventory: $50,000
  • Ending raw materials inventory: $20,000
  • Average inventory: ($50,000 + $20,000) / 2 = $35,000
  • Raw Material Inventory Turnover = $720,000 / $35,000 = 20.57

This turnover ratio of 20.57 indicates that the company completely replaces its average raw material inventory about 20.57 times per year.

A higher turnover ratio generally suggests more efficient inventory management, as it implies the company is using its raw materials quickly and not letting them sit in storage for extended periods. However, the ideal turnover rate can vary by industry and specific business needs.

Best Practices for Raw Materials Inventory Management

Following best practices such as implementing robust inventory tracking systems, regularly auditing stock levels, and establishing efficient reorder processes can significantly improve your inventory control. Let’s understand these practices in detail.

five best practices for raw materials inventory management by softwaresuggest

1. Implement Inventory Management Software

Adopting a modern inventory management software solution is fundamental to effective raw materials control. These platforms provide real-time insights into inventory levels, streamline tracking procedures, and offer crucial data for decision-making. Key features to look for include

  • Barcode or RFID scanning capabilities for accurate and quick data entry
  • Real-time inventory updates across all connected devices and locations
  • Automated reorder notifications based on predefined thresholds
  • Integration with other business systems like accounting and production planning
  • Reporting and analytics tools for inventory optimization

By digitalizing your inventory management, you can reduce human error, save time on manual processes, and gain actionable insights to make informed decisions about your raw materials procurement and usage.

2. Conduct Regular Audits and Cycle Counts

Consistent inventory audits and periodic counts help pinpoint and correct discrepancies between actual stock and recorded inventory figures. This facilitates early identification of problems such as missing items, product damage, or misplaced goods.

Moreover, implementing cycle counts minimizes disruptions to daily operations compared to full shutdowns required for complete audits. Here are two ways to implement it effectively.

  • Full inventory audits: Conduct comprehensive counts of all raw materials, typically annually or bi-annually.
  • Cycle counting: Conduct regular counts of specific inventory groups, with a focus on items of high value or those with rapid turnover rates.

3. Utilize ABC Analysis

The ABC analysis facilitates a more effective distribution of resources and enhances overall inventory management. It allows you to focus on managing high-value items, implement tailored control policies, and optimize storage locations.

This improves inventory accuracy while making efficient use of resources. It also helps concentrate cycle counting efforts on critical items. Inventory items can be classified into three main categories.

  • A items: High-value materials that represent a significant portion of inventory value despite comprising a small fraction of total stock.
  • B items: Moderate-value materials with mid-range impact on overall inventory value.
  • C items: Low-value materials with a large percentage of inventory items but a small portion of the total value.

An auto parts company in Thailand applied the ABC classification to its raw materials inventory. By focusing on high-value items and using appropriate ordering methods for each category, they reduced their total inventory costs by over 44% three consecutive years.

4. Establish Reorder Points

Setting optimal reorder levels ensures balanced stock and prevents excess or shortage. In fact, this fine-tunes inventory control and minimizes stockout and overstock risks. Moreover, frequent evaluation and modification of reorder points foster a flexible and responsive inventory framework.

To establish effective reorder points.

  • Calculate lead times: Determine order-to-delivery duration for materials.
  • Determine safety stock levels: Maintain buffers for demand variations or supply delays.
  • Consider usage rates: Analyze historical data to predict future consumption.
  • Factor in economic order quantities: Balance ordering and holding costs for cost-effectiveness.

5. Build Strong Supplier Relationships

Strong supplier relationships enhance inventory management effectiveness. They lead to reliable deliveries, shorter lead times, and better stock-level management. Improved communication allows for proactive problem-solving. These relationships can offer bulk purchase discounts and favorable payment terms, further reducing inventory costs.

Here’s how you can build and maintain strong supplier relationships.

  • Establish clear communication channels and regular check-ins
  • Share forecasts and production plans to help suppliers anticipate needs
  • Pay invoices on time and address issues promptly
  • Consider long-term contracts for critical materials
  • Provide feedback and collaboratively resolve quality or delivery issues

Common Challenges in Managing Raw Material Inventory

The four most common challenges in managing raw material inventory are overstocking and understocking, supplier reliability, market fluctuations, and quality control issues. Let’s understand these challenges in detail.

four common challenges in raw material inventory by softwaresuggest

1. Overstocking & Understocking

Overstocking ties up capital and increases storage costs, while understocking can lead to production delays and lost sales. This balance is crucial for efficient operations and financial health.

Common causes of overstocking and understocking.

  • Inaccurate demand forecasts
  • Improper safety stock levels
  • Unexpected spikes in demand
  • Supply chain disruptions
  • Poor inventory tracking

To address this, implement accurate forecasting methods, regularly review and adjust safety stock levels, and use real-time inventory tracking systems.

2. Supplier Reliability

Dependable suppliers are essential for maintaining consistent raw material inventory. Unreliable suppliers can cause significant disruptions to your operations and impact your bottom line.

Common issues with supplier reliability.

  • Inconsistent delivery times
  • Sudden price changes
  • Inability to meet increased demand

To mitigate supplier reliability issues, develop strong relationships with multiple suppliers, implement a supplier rating system, and establish clear communication channels and expectations.

3. Market Fluctuations

Raw material markets can be volatile, impacting both availability and pricing. This volatility can lead to unexpected challenges in inventory management and cost control.

Effects of market fluctuations include

  • Unpredictable raw material costs
  • Supply shortages or surpluses
  • Difficulty in long-term planning and budgeting

To manage market fluctuations, use forecasting tools to anticipate market trends, implement hedging strategies for price-sensitive materials, and maintain flexible contracts with suppliers.

4. Quality Control Issues

Maintaining consistent quality in raw materials is crucial for product integrity and customer satisfaction. Quality control challenges can lead to production issues and increased costs.

Common quality control problems are

  • Variations in material specifications
  • Contamination during storage or transport
  • Inconsistent quality across different batches

To address quality control issues, implement strict incoming inspection procedures and invest in proper storage and handling facilities. Additionally, provide regular feedback to suppliers while working closely with them on quality improvements.

Conclusion

Proper raw materials inventory management enhances production efficiency, improves cash flow, and boosts competitiveness. However, manufacturers face ongoing challenges such as stock imbalances, supplier inconsistencies, market volatility, and quality control issues. Proactive strategies like conducting routine audits, applying ABC analysis, setting strategic reorder points, and cultivating robust supplier relationships can effectively mitigate these risks.

Ready to optimize raw materials inventory? Begin by choosing the right inventory management software.

Rohit
About the author

Rohit Rajpal is an accomplished writer with a deep understanding of technology, digital marketing, and customer service. He brings extensive expertise in ERP and CRM systems, blending technical insight with clear, engaging content. Rohit’s work bridges the gap between complex concepts and accessible communication for diverse audiences.

knowledge image
Your Business Deserves Better Software!

Upgrade your business operations with modern software solutions tailored to your needs.

subscribe image
Let’s Stay in Touch

Subscribe to our newsletter & never miss our latest news and promotions.

people subscribed+21K people have already subscribed 
Related Articles
sitemap
Share This