“Inventory” is a tricky word because it means different things to different people. If you are an inventory manager, inventory is the number of units you have on hand at any given time. If you are an accountant, inventory is an asset on a balance sheet tracked by its monetary value. To complicate things further, there are several different types of inventory, and the ones you need to count (or value) depend on who you are and the type of business you run.
Confused? You’re not the only one! Continue on for all you need to know about inventory for ecommerce brands and online retailers.
What Type of Ecommerce Business Are You?
Most ecommerce businesses fall into one of three camps:
1. They manufacture their own goods — that is, they purchase raw materials and/or components, design and build something new out of these materials in their own facilities, and sell the finished goods online.
2. They outsource some or all of the manufacturing process — but they do so while retaining ownership over how and what is manufactured under their brand. In this scenario, the ecommerce business is considered a contract manufacturer, and the factory is considered a subcontractor.
3. They act as retailers — that is, they aggregate finished goods from many different brands or manufacturers and provide a branded, online store where customers can buy them.
Ecommerce manufacturers need to track different types of inventory than ecommerce retailers do. To understand this, first we’ll take you through the inventory types that matter to ecommerce manufacturers; then we’ll cover inventory types for ecommerce retailers.
Inventory Types for Manufacturers
An ecommerce business that manufactures its own goods, whether in-house or outsourced, is usually responsible for ordering and managing the raw materials and paying for all the production costs. As a result, they have to track all the inventory used to produce their products, even if the manufacturing is done elsewhere.
Raw Materials Inventory: Unprocessed materials or components needed to produce the items you sell. Raw materials are either produced by the manufacturer itself, or purchased in bulk from a supplier and stored until they go into production. Raw materials inventory costs must include the cost of freight, storage, and handling.
Work-in-Process Inventory (WIP): Inventory that is currently on the factory floor being turned into finished goods. It cannot be counted as raw materials, nor as finished goods, so it is referred to as WIP inventory.
Maintenance, Repair, and Operations Inventory (MRO): Items that are used or consumed during the production process that are not part of the actual product, such as machine lubricant, disposable gloves, uniforms, machinery depreciation, batteries, utilities, cleaning supplies, etc.
Finished Goods Inventory: Inventory that is finished, packaged, and ready for sale. Manufacturers use the term, “finished goods,” while retailers generally refer to it as merchandise inventory or stock.
Packing Materials Inventory: This includes any interior packing materials (like dunnage) as well as the exterior packaging and any protective coverings needed to prep the goods for shipment to the customer, whether a wholesaler, retailer, or end consumer.
Safety Stock: Extra stock kept on hand to cover the ecommerce business in case of unexpected demand or supply chain issues.
Excess or Obsolete Inventory: Also called dead stock, this includes unused raw materials past their expiration dates or unsold finished goods or that are no longer sellable for one reason or another.
Inventory Types for Ecommerce Businesses
An ecommerce business that acts as a retailer usually only has one type of inventory to track and value: merchandise inventory (or stock), plus a few subcategories of merchandise inventory.
Merchandise Inventory: Inventory that is in stock and ready for sale, usually purchased as finished goods from a manufacturer or wholesaler.
Safety Stock: Extra inventory kept in reserve to cover the business in case of an unexpected surge in demand or supply chain issues.
Excess or Obsolete Inventory: Also called dead stock, this includes perishable goods past their expiration dates, or unsold inventory that is no longer sellable for one reason or another.
Other Types of Inventory
Cycle Stock: Also called working stock, this is the amount of inventory an ecommerce business keeps on hand to fill a typical number of orders during a certain period of time. Cycle stock is replaced as soon as it is sold.
Anticipatory Stock: Inventory purchased and stored in anticipation of a change of season or a major event such as a Black Friday or Cyber Monday sale.
Psychic Stock: Inventory that is not for sale but is used for marketing purposes, such as free samples, photo shoots, displays, etc.
Pipeline Inventory: Also called in-transit inventory, this is inventory that has been purchased by the ecommerce business or retailer but is not yet in their hands. It might be on a truck, in a shipping container, or still in the manufacturing process.
Physical Inventory: The actual number of physical units in stock determined by a physical count conducted by actual human beings in the warehouse. This term is used to differentiate physical inventory from digital inventory, or the inventory that should be on the shelves according to warehouse inventory software and digital scanners.
Digital Inventory: The number of units in stock determined by software and digital scanners. Physical counts (or inventory audits) are conducted periodically to verify these numbers.
Inventory Counting vs. Inventory Accounting
For ecommerce businesses, inventory is their most valuable asset and also one of their largest costs. Inventory managers are hyper-focused on inventory levels (the number of physical units for each type of inventory on hand) to prevent overstocks, stock outs, and backorders. Tracking the same inventory counts over time helps managers forecast future demand, establish reorder points and economic order quantities, identify cyclical trends, and catch discrepancies due to error or shrinkage. All of this is important because while carrying too much inventory can eat into profitability, carrying too little results in lost revenue and negatively affects customer service.
While inventory managers track the number of units, accounting and finance teams track the value (cost) of those units. You need a CPA to figure this all out accurately because costs go up and down, there are direct and indirect costs, actual costs need to be compared to projected costs, and this all affects margins and profitability.
Accountants use several different inventory accounting methods such as FIFO, LIFO, and Weighted Average to assign a value to each unit of inventory. These values are also used to calculate cost of goods sold (COGS), manage profit margins, and report assets held at the end of the year. A reliable ecommerce accounting team must be familiar with the many different inventory types listed above, as well as several other types of inventory used only for bookkeeping, tax filing, and financial reporting purposes.
Inventory Types for Accountants
Beginning Inventory: the value of the inventory you have in stock at the beginning of a specific accounting period. Beginning inventory includes the costs incurred to make or purchase that inventory, plus holding costs or carrying costs (how much it costs you to store it).
Ending Inventory: the value of the inventory you have in stock at the end of a specific accounting period. To calculate ending inventory you start with last period’s beginning inventory, add all costs for new purchases made since then, then subtract the cost of goods sold (COGS).
Periodic Inventory: A method used to count inventory in which all inventory is physically counted periodically—whether weekly, monthly, quarterly, or annually. Cycle counting is a form of periodic inventory in which only a portion of the inventory is counted at one time, but the inventory teams eventually cycle through all of the inventory. Cycle counting minimizes disruption to the business.
Perpetual Inventory: An inventory tracking method that requires robust 3PL fulfillment software to maintain precise inventory counts at all times. In other words, as soon as a unit is sold it is removed from the inventory count, rather than waiting until the end of the period to reconcile.
Inventory Write-down: An accounting process that reduces the value of unsold inventory to its net realizable value (cash expected minus any costs to sell) when that value is lower than its cost.
Inventory Write-off: The accounting process of removing obsolete inventory from a company’s assets when it has lost all of its value due to damage, deterioration, theft, or obsolescence.
Inventory Made Easy
As you can see, inventory is complicated. The good news is that no matter what type of inventory you’re tracking, perpetual inventory and order management systems make everything easier. Ecommerce businesses that don’t want to invest in intensive inventory systems can take advantage of third party logistics (3PL) partners that provide the technology and software integrations for them. For example, ShipMonk’s industry transforming fulfillment software provides order, inventory, and warehouse management tools that are both powerful and completely user-friendly. With our 3PL software, inventory managers, accounting teams, and finance teams all have the numbers they need at their fingertips.
So whether you’re a struggling inventory manager or a frustrated CPA, our tech-forward fulfillment services can make your life a thousand times easier. Contact ShipMonk today for a look at our inventory management capabilities, fulfillment services, and easy-to-use 3PL software.