# What Is Inventory? Definition, Types, and Examples

![Inventory](https://www.investopedia.com/thmb/Xdfu5R9xDvx09JWrpq2XV_-EFqc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/TermDefinitions_Inventory_finalv2-174a95eaeac3409d971256da7ecb164b.jpg)

*Inventory management allows businesses to minimize inventory costs as they create or receive goods on an as-needed basis. — Mira Norian / Investopedia*

> **Definition**
>
> Inventory is the raw materials and finished goods a company holds for production and sale.

## Inventory Definition

Inventory is the vital [assets](https://www.investopedia.com/terms/a/asset.asp) a company has in production and in goods produced that are available for sale. Inventory encompasses raw materials, work-in-progress (WIP), and finished goods.

Inventory plays a crucial role in driving revenue and earnings, since efficient inventory levels ensure that products are available to meet customer demand without tying up excess capital. It is listed as a current asset on company [balance sheets](https://www.investopedia.com/terms/b/balancesheet.asp).

To determine the value of inventory, businesses commonly use inventory management techniques such as first-in, first-out (FIFO), last-in, first-out (LIFO), and the weighted average method.

[Inventory turnover](https://www.investopedia.com/terms/i/inventoryturnover.asp) represents one of the primary sources of revenue generation and subsequent earnings for a company's shareholders. High turnover generally signals strong sales and effective management, while low turnover may suggest overstocking or weak demand, both of which can negatively impact a company’s profitability.

### Key Takeaways

*   Inventory is a crucial asset for companies as it includes raw materials, work-in-progress items, and finished goods, all of which are essential in revenue generation and meeting customer demands.
*   Businesses deploy different valuation methods for inventory, including FIFO, LIFO, and the weighted average method, which impact financial statements and tax computations.
*   Effective inventory management, such as implementing a just-in-time (JIT) system, helps reduce costs associated with holding excess inventory and minimizes risks, including obsolescence and spoilage.
*   Inventory turnover ratio is a significant measure used by companies to understand the efficiency of their sales processes, influencing production and sales strategies as well as indicating how well a company is performing against its competitors.

## Deep Dive into Inventory: Types and Importance

Inventory is a crucial asset for any [company](https://www.investopedia.com/terms/c/company.asp). It refers to goods used in production or finished goods held by a company during regular business. There are three general categories of inventory: raw materials (any supplies that are used to produce finished goods), [work-in-progress (WIP](https://www.investopedia.com/terms/w/workinprogress.asp)), and finished goods—those that are ready for sale.

As noted above, inventory is classified as a current asset on a company's balance sheet, and it serves as a buffer between [manufacturing](https://www.investopedia.com/terms/i/ism-mfg.asp) and order fulfillment. When an inventory item is sold, its carrying cost transfers to the [cost of goods sold (COGS)](https://www.investopedia.com/terms/c/cogs.asp) category on the income statement.

Under U.S. GAAP (Generally Accepted Accounting Principles), inventory can be valued in three ways. These methods are the:

*   [First-in, first-out (FIFO)](https://www.investopedia.com/terms/f/fifo.asp) method, which says that the COGS is based on the cost of the earliest purchased materials. The carrying cost of the remaining inventory, on the other hand, is based on the cost of the latest purchased materials
*   [Last-in, first-out (LIFO)](https://www.investopedia.com/terms/l/lifo.asp) method. This method states that the COGS is valued using the cost of the latest purchased materials, while the value of the remaining inventory is based on the earliest purchased materials.
*   Weighted average method, which requires valuing both [inventory](https://www.investopedia.com/terms/g/gmroi.asp) and the COGS based on the average cost of all materials bought during the period.  
    

> **Important**
>
> Company management, analysts, and investors can use a company's inventory turnover to determine how many times it sells its products over a certain period of time. Inventory turnover can indicate whether a company has too much or too little inventory on hand.

## Inventory Management Considerations and Consignment Practices

Many producers partner with retailers to consign their inventory. [Consignment](https://www.investopedia.com/terms/c/consignment.asp) inventory is the inventory owned by the supplier/producer (generally a wholesaler) but held by a customer (generally a retailer). The customer then purchases the inventory once it has been sold to the end customer or once they consume it (e.g., to produce their own products).

The benefit to the supplier is that their product is promoted by the customer and readily accessible to [end users](https://www.investopedia.com/terms/e/end-user.asp). The benefit to the customer is that they do not expend [capital](https://www.investopedia.com/terms/c/capital.asp) until it becomes profitable to them. This means they only purchase it when the end user purchases it from them or until they consume the inventory for their operations.  

## Exploring the Different Types of Inventory

Remember that inventory is generally categorized as raw materials, work-in-progress, and finished goods. The Internal Revenue Service (IRS) also classifies merchandise and supplies as additional categories of inventory.

[Raw materials](https://www.investopedia.com/terms/r/rawmaterials.asp) are unprocessed materials used to produce a good. Examples of raw materials include:

*   Aluminum and steel for the manufacture of cars
*   Flour for bakeries that produce bread
*   Crude oil held by refineries

Work-in-progress inventory is the partially finished goods waiting for completion and resale. WIP inventory is also known as inventory on the production floor. A half-assembled airliner or a partially completed yacht is considered to be a work-in-progress inventory.

Finished goods are products that go through the production process and are completed and ready for sale. Retailers typically refer to this inventory as merchandise. Common examples of merchandise include electronics, clothes, and cars held by retailers.  

## Effective Inventory Management Strategies

Holding a large inventory for an extended period is typically not ideal for a business. That's because of the challenges it presents, including [storage costs](https://www.investopedia.com/terms/t/transportation-and-storage-costs.asp), spoilage costs, and the threat of obsolescence.

Keeping too little inventory also has drawbacks. For example, companies risk losing [market share](https://www.investopedia.com/terms/m/marketshare.asp) and profit opportunities.

[Inventory management](https://www.investopedia.com/terms/i/inventory-management.asp) forecasts and strategies, such as a [just-in-time (JIT)](https://www.investopedia.com/terms/j/jit.asp) inventory system (with [backflush costing](https://www.investopedia.com/terms/b/backflush-costing.asp)), can help companies minimize inventory costs because goods are created or received only when needed.

It's always a good idea for companies to invest in a good inventory management system. This is especially true for larger businesses with multiple sales channels and storage facilities. These systems are able to identify waste, low turnover, and fraud/robbery.

## Understanding Inventory Turnover and Its Impact on Profitability

Inventory [turnover](https://www.investopedia.com/terms/t/turnover.asp) is a key part of inventory management. Also called stock turnover, this is a metric that measures how much of a company's inventory is sold, replaced, or used and how often. This figure provides insight into how profitable a company is and whether there are inefficiencies that need to be addressed.

Consumer [demand](https://www.investopedia.com/terms/d/demand.asp) is a key indicator that can determine whether inventory levels will turn over at a quick pace or if they won't move at all. Higher demand typically means that a company's products and services will move from the shelves into consumers' hands quickly, while weak demand often leads to a slow turnover rate.

A [company's inventory turnover](https://www.investopedia.com/articles/personal-finance/081215/know-accounts-receivable-inventory-turnover.asp) is often expressed as a ratio. The inventory turnover ratio is calculated using the following formula:

> Inventory Turnover Ratio = COGS ÷ Average Value of Inventory  

Company leaders use this figure to decide on producing certain products and identify potential issues.  

## How Do You Define Inventory?

Inventory refers to a company’s goods and products that are ready to sell, along with the raw materials that are used to produce them. Inventory can be categorized in three different ways, including raw materials, work-in-progress, and finished goods.

In accounting, inventory is considered a current asset because a company typically plans to sell the finished products within a year.

Methods to value the inventory include last-in, first-out (LIFO), first-in, first-out (FIFO), and the weighted average method.

## What Is an Example of Inventory?

Consider a fashion retailer such as Zara, which operates on a seasonal schedule. Because of the fast fashion nature of turnover, Zara—like other fashion retailers—is under pressure to sell inventory rapidly. Zara's merchandise is an example of inventory in the finished-product stage. On the other hand, the fabric and other production materials are considered a raw material form of inventory.

## What Can Inventory Tell You About a Business?

One way to track the performance of a business is the speed of its inventory turnover. When a business sells inventory at a faster rate than its competitors, it incurs lower holding costs and decreased opportunity costs. As a result, they often outperform, since this helps with the efficiency of its sale of goods.

## The Bottom Line

Inventory is an important business asset for revenue generation and shareholder earnings. It falls into three main categories: raw materials, work-in-progress (WIP), and finished goods.

Inventory is classified as a current asset on a business's balance sheet, serving as a buffer between manufacturing and order fulfillment.

To effectively manage these assets, companies enact inventory management strategies such as just-in-time (JIT) systems, which aim to reduce holding costs and enhance operational efficiency by receiving goods only when they are needed for production or sale.

Inventory turnover, which measures how often a business turns over its inventory in a given time period, is a key metric for assessing the company's performance and profitability.

The above example of Zara, a leading fast-fashion retailer, demonstrates that a highly responsive inventory system will allow the company to move designs from concept to store shelves in just a few weeks. This approach minimizes excess stock, reduces markdowns, and keeps product offerings aligned with current market trends.

Ultimately, effective inventory management and turnover analysis enable better business decisions, improve operational efficiency, and strengthen financial performance.  

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Publication 538 (01/2022), Accounting Periods and Methods: Items Included in Inventory](https://www.irs.gov/publications/p538#en_US_201809_publink1000270719).”
>     
> 2.  Harvard Business School, Digital Initiative. "[Zara: Disrupting the Traditional Cycle of Fashion](https://digital.hbs.edu/platform-rctom/submission/zara-disrupting-the-traditional-cycle-of-fashion/)."