What Are the 4 Types of Inventory?

Inventory represents goods held by a business for sale or for use in the production of goods and services. It appears as a current asset on a company’s balance sheet. Maintaining appropriate inventory levels is important for operations, ensuring customer demand can be met while avoiding excessive holding costs. For businesses involved in manufacturing, production, or direct sales, inventory is a significant component of their financial position and operational efficiency.

Raw Materials

Raw materials are the fundamental components a company purchases to convert into finished products through a manufacturing process. Examples include wood for furniture, steel for vehicle manufacturing, or grains processed into food products.

Businesses track raw materials carefully, often valuing them using methods like First-In, First-Out (FIFO), Last-In, First-Out (LIFO), or the weighted-average cost method. These valuation choices impact the cost of goods sold and the reported taxable income for a business. The cost of raw materials includes the purchase price, freight, and any other costs directly attributable to bringing the materials to their current location and condition.

Work-in-Process

Work-in-process (WIP) inventory includes goods that have begun the manufacturing process but are not yet complete. These partially finished products require further labor, additional materials, or manufacturing overhead to become finished goods. Examples range from a car chassis on an assembly line awaiting engine installation to dough baking in an oven before becoming bread, or partially edited video footage.

The cost of WIP inventory accumulates direct materials, direct labor, and manufacturing overhead costs as production progresses. Businesses must accurately track these costs because they directly influence the reported value of inventory on the balance sheet and the eventual cost of goods sold when products are completed and sold.

Finished Goods

Finished goods are products that have completed the entire manufacturing process and are ready for sale to customers. These items have undergone quality control checks and are often packaged for distribution or direct retail. Examples include fully assembled furniture pieces, packaged food items ready for grocery shelves, or tested and boxed electronic devices.

The cost of finished goods includes all accumulated direct materials, direct labor, and manufacturing overhead incurred during their production. Once these goods are sold, their cost is transferred from inventory on the balance sheet to the cost of goods sold on the income statement. This transfer directly impacts a company’s gross profit. Businesses must accurately determine the cost of finished goods to report profitability correctly and to manage pricing strategies.

Merchandise Inventory

Merchandise inventory consists of goods purchased by a business for resale to customers without any further manufacturing or significant transformation. This type of inventory is typical for retail, wholesale, and distribution companies. Examples include clothing in a retail boutique, appliances in an electronics store, or groceries stocked in a supermarket.

Unlike manufacturing companies, businesses with merchandise inventory do not incur production costs beyond the initial purchase price. Their inventory costs primarily include the amount paid to suppliers, along with any freight-in charges to bring the goods to their location. Managing merchandise inventory involves tracking purchases, sales, and returns, often through perpetual or periodic inventory systems. Losses due to theft or damage, known as shrinkage, can also affect the reported value of merchandise inventory, requiring adjustments to accurately reflect assets and taxable income.