Raw Materials Inventory Management: The Definitive Guide
Raw materials inventory is the total cost of all the parts you have in stock, but not yet used in production.
This is the raw materials inventory management guide for ambitious manufacturers and owners of scaling companies looking for a better understanding of how to handle their inventory.
This guide applies to manufacturers of all stripes and shows you how your management of raw material stock should change as your business grows.
So, without further ado, here’s everything you need to know about raw materials inventory management to take your business to the next level.
What is Raw Materials Inventory Management?
There are two types of raw materials: direct materials (DM) and indirect materials (IM).
Components which are part of your final product. Examples of direct materials are: the leather used to manufacture leather bags, the silk used to manufacture silk scarves, the wood used to manufacture wooden dining tables.
Components which are not part of your final product, but which are consumed during the manufacturing process. Examples of indirect materials are glue, oil, cleaning supplies, disposable tools, light bulbs, etc.
As your orders increase, you may order a ton of extra materials, assuming that the more safety stock you have, the better.
Well, imagine your raw materials inventory was raw produce in a supermarket. Stocking up to last you until next Christmas could be a bad move. Not just a small error, but one that could mean “checkmate” for a business.
If items in stock are not sold in time, it becomes “obsolete” (or spoiled) and becomes unsellable. This spells a huge loss for the business. Not to mention the many costs incurred during the storage, maintenance, and transportation of the produce or material inventory.
It all increases your manufacturing costs. Your raw materials may not spoil like supermarket produce, but the result of keeping large amounts of raw material stock around is the same.
How to Calculate Raw Materials Inventory Value
Manufacturers, regardless of the size of their factory floor, will need to account for their raw materials, business supplies, and finished products.
To do this, you’re going to have to determine the ending inventory value at the end of each period.
To do this, you going to need to add the number of units you manufactured and the raw materials you purchased during the period to the number of units at the beginning of a period.
For example, let’s say you’re a shoe manufacturer and want to account for the number of laces you have:
50 laces + 100 laces = 150 laces
Now, subtract that number by the amount of inventory you have used during this period to find out your ending inventory.
Let’s imagine you used 60 laces during production:
150 laces – 60 laces = 90 laces
Time to uncover the value of your remaining inventory, and this is simple, simple multiple your remaining inventory by the cost for one unit of raw material:
$90 laces x $1.50 = $135
And there you have it, the remaining raw material inventory level’s value comes in at $135. A relatively easy formula to follow when calculating the value of your raw materials.
However, what about for those of you who have different materials or even products at different prices? It can be complicated to calculate the value for each different item.
In this instance, it’s best to use the weighted inventory method for evaluating the value of your raw material.
How to Calculate Raw Material Value with Weighted Average Costing
Calculating the value of items with the weighted inventory method can be tricky. So, let’s imagine you sell two products, A and B:
— Product A costs $4 and sells at a rate of 80%; and
— Product B costs $2 and sells at a rate of 20%.
The formula for this scenario will look like this:
($4 x 0.8) + ($2 x 0.2) = $3.60
If using the weighted inventory formula seems intimidating, there are automated solutions available on the market, they will help you with raw material inventory management, and also automatically calculated your weighted inventory costs for you.
Best Raw Material Inventory Management Techniques
Don’t Obsess Over “Work-in-progress"
Typically, companies start with finished product inventory tracking, then implement basic raw material stock management, followed by more complex work-in-progress management.
We strongly recommend not to try to jump to the latter immediately.
Although proper inventory management has great benefits it also comes at a cost — the cost of time and resources to keep it running and up-to-date.
Thus, if it’s possible, then start with basic raw materials inventory management and do not try to immediately track different stages of production. Just take stock of your raw materials and finished products.
It's better to have something simple working well than to have something complex that does not work properly.
Keep everything lean and increase the complexity of inventory management only if there is a clear business need to do so.
Update Safety Stock and Reorder Level Points
Safety stock describes the amount of inventory a business keeps in the warehouse to protect against spikes in demand or shortages in supply.
A good reorder point ensures that your business typically does not dip below your safety stock levels.
Most manufacturers employ some kind of minimum inventory principles for raw materials used in production.
Manufacturers often fail to calculate raw materials used regularly. As a result, these raw materials inventory levels do not stay up-to-date. All the events below should trigger an adjustment:
— A significant change in sales volume;
— Major changes in supply lead times; and
— A change in production volumes.
Also, don't forget to adjust safety stock and reorder point levels to account for seasonal changes like an upcoming holiday season, for example.
Keeping these levels up-to-date ensures you always have just the right amount of raw material inventory in your warehouse, so you won’t have too much cash tied up.
Don’t Try to Put All Materials on Production Recipes (Bill of Materials)
Having a proper raw material inventory management in place does not mean you should track every material consumed in your production.
For example, there could be several indirect materials consumed during the production process (nails, screws, buttons, and so on) that do not cost a lot and are typically purchased by the box in high volumes.
It often makes sense not to have such materials on your bill-of-materials. Instead, cost them at the time of purchase and do not try to track every single piece consumed in production.
It is important to get the high-cost raw material stock in place on a production recipe so you know early on if this is a profitable product.
Don’t spend hours to save pennies. Focus on what has a greater effect on your margins.
PRO TIP: The manufacturing industry is a diverse one, and different manufacturers need their software to perform different functions. For example, those working in the food and beverage need software that can perform food traceability.
Use Industry-Standard Metrics to Find Out What Works for You
Your business is unique, and what works for one business might not work for another.
The basic guiding principles of this are simplicity, directness, and freedom.
There is no dogmatic loyalty to one technique. This is the key to overcoming any challenging situation for your manufacturing business. Take what works and discard the rest.
The key for you is to use all the tools at your disposal to form your unique style of manufacturing. You can find the secret formula to your optimal raw materials inventory game.
That’s how modern businesses can rise to the top.
PRO TIP: There are material requirements planning software available on the market that gives manufacturers all the tools they need to get their raw material under control.
How Much Energy Needs to Go into Raw Materials Inventory Management
Now you know what is raw materials, how much elbow grease are you going to need to put into your raw material?
Have you heard of the Pareto Principle? The famous 80/20 rule that 80% of the results you get come from 20% of the input.
You could be working your socks off for 100 hours a week, but only 20 of those hours get the majority of your results.
What’s more, 20% of the stuff you learn about managing your raw materials inventory is used for 80% of your operations. And guess what? This 20% is the tried-and-tested fundamentals that go to the heart of inventory management.
Get your foundation right, and the rest will follow. Most disciplines have a core set of principles to learn that will put you at the top of the game if you take the time to master them.
Are you spending too long on stocktaking, only to find mistakes still happen? Maybe using the perpetual inventory workflow could be a better solution for your inventory management.
Calculate how much you pay to keep each square foot of stock each month. The result may surprise you.
You could adopt principles of just-in-time (JIT) manufacturing. We recommend you don’t go for 100% JIT at this stage. Find out what raw material stock you have lying around the longest and ask yourself: why does this need to be here?
By keeping less stock, your inventory turnover ratio (IRT) should be increasing. There’s no need to keep raw materials hanging around for months on end. If your IRT is low, you could be losing a good deal of money each month on carrying costs. Find out how to reduce wasted money on keeping raw materials here.
Are your costs overtaking your income? Figure out your cost of goods sold (COGS) and calculate how raw materials used in production affect your bottom line.
Spreadsheets are fine for calculating turnover. But this doesn’t take into account every cost you have. Dedicated software helps you calculate your actual profitability, as it is designed to cover every aspect of your manufacturing business.
Why Solid Raw Materials Inventory Management is Vital for Growing Manufacturers
Imagine you were going on a round-the-world trip.
You could take two large suitcases filled with clothes for every weather condition. You might think you’re being smart because you’re prepared for any eventuality, but in reality, it weighs you down and costs you more money to transport.
Contrast this to a single backpack. The money you save on baggage charges can be used to purchase what you need, as you need it. You can run for a bus at short notice, and people are more willing to give you a lift.
The first option seems less risky, but progress is so slow it is less effective overall.
The second option is the road to success. You haven’t put all your eggs into one basket. You can change direction at a moment’s notice and take a route that makes more sense.
The same goes for keeping extra raw materials inventory lying around.
What you thought was a boon for your business, could in fact, be weighing it down.
Get on top of your raw material inventory management and watch your business become so much easier to manage.
Raw materials are the lifeblood of your craft or artisan business. And just as with the body, it must flow to where it is needed in the right amount. Too much can be just as dangerous as too little.
Broadly speaking, as a scaling manufacturer you typically handle three different types of inventory:
— Raw materials inventory;
— Work-in-progress; and
— Finished products.
The average time a business focuses on each type of inventory changes at different stages in the business’s life.
During the startup stage, companies tend to focus more on finished products. This makes a lot of sense as getting products to customers is the top priority. You have to make a name for yourself, and your product is everything.
That’s not to say this isn’t always a focus, just that the smaller business does not have to focus on raw material inventory management very much at this stage,
As time passes, and the business grows, the owner might shift their focus towards manufacturing and small business inventory management efficiency.
What was once barely a concern for the business owner, becomes the number one thing on their mind.
24 hours a day, seven days a week. It seems like inventory management is taking over their life.
The business owner might be spending more time than ever on managing their raw material stock, with little to show for it.
More raw materials pile up, seemingly enough to last for any unforeseen occurrence. This increases your inventory expenditure on your balance sheet.
Not to mention the number of man-hours lost on tracking it all.
Before you know it, you are spending more than ever to sell a single unit of product.
Your business is bigger, it may even be more profitable. But if your overheads are destroying a higher percentage of your income, then what are you doing it all for?
Below are our top recommendations for your raw materials management and planning. Use this knowledge wisely, and watch your factory floor become better, faster, and stronger. It will become battle-hardened like a Samurai warrior.
PRO TIP: When aspiring to improve your raw material management, it’s best practice to look for a system that offers integration with e-commerce and accounting platforms such as QuickBooks raw material inventory software.
Overcoming Challenges with Raw Material Data Management
As you have probably already gathered from this article, practicing solid raw material inventory management can be a difficult affair.
So, before we move on to the best solution for handling your raw material, here are some of the things you’ll need to take into consideration when improving your raw material inventory management:
Planning and Forecasting
Improving your raw material inventory management is one thing, but having a dynamic management system that considers your demand planning will help you maintain an ideal amount of inventory at all times.
To have the right amount of raw material stocked when you need it is only possible by collecting data from your sales, production lines, and everywhere else on your supply chain. It is possible to do it with inefficient spreadsheets. However, it can be difficult having to make constant manual updates.
You might know how to calculate the value of your raw material, but that doesn’t mean you have accurate costings of how much it costs to manufacture your products. Other costs you need to track include your raw materials, manufacturing overheads, and labor used in production, and due to various factors, these costs often change (meaning items in your inventory don’t have the same value as others).
Tracking these three things alone is going to be extremely time consuming and difficult. This is why many manufacturers turn to Smart Manufacturing Software to help automate and track their raw inventory management software.
Use Smart Raw Materials Inventory Management Software
You could have the best managerial mind in the world. Your industry knowledge could be second to none. But if you don’t have the right tools, your business could still be dead in the water.
Managing raw materials inventory in a scaling manufacturing business without dedicated software is like fighting a Samurai warrior without a Katana. You will lose, sooner or later.
Using undedicated software, or a pen-and-paper method is like using a brittle training sword. You might deflect a few strikes, but your blade will break eventually.
But just having the software is like having the best sword in the world, and no skill. You will still be outmatched and beaten.
However, many manufacturers sell from e-commerce platforms (the most popular platform being Shopify). It's important to find a system that can help you with your Shopify inventory management, and organize your business (including sales, supply chain management, and production).
PRO TIP: 43% of small businesses do not track their inventory. Using a Shopify order management system gives you a huge head start against the competition.
But, regardless of your choice, you're going to need to combine the best tools with the best knowledge.
You can apply the knowledge above while using a spreadsheet, but you risk it only being 20% effective.
You might be asking:
How does manufacturing ERP software reduce inventory levels? It does it by...
— Getting work-in-progress out the door and to the customer faster;
— Calculating raw materials used so you can set up optimal reorder points; and
— Automating repetitive tasks so you aren’t bored out of your mind counting buttons.