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Here is the ultimate raw materials inventory management guide for ambitious manufacturers and owners of scaling companies looking to understand better how to handle their inventory.
This guide applies to all manufacturing industries that handle raw materials and details how your raw material stock management evolves as your business grows. By the end of the article, you’ll fully understand the definition of raw materials, how to manage them, and how to calculate the raw materials used. 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 material inventory management?
Raw materials inventory is the total cost of a manufacturer’s components, subassemblies, and supplies in stock that are not currently in production. There are two types of raw materials that go into making a final product:
- Direct materials (DM)
- Indirect materials (IM)
Direct materials are the components that are part of your final product. For example, direct materials are the leather used to manufacture leather bags, silk used to manufacture silk scarves, and wood used to manufacture wooden dining tables.
Indirect materials are the components that are not part of your final product but are used during the manufacturing process. Examples of indirect materials are:
- Cleaning supplies
- Disposable tools
- Light bulbs
Why is raw material inventory management important?
Raw material inventory management is the process you or your managers will follow to ensure enough stock on hand, from direct materials to indirect materials, to keep production moving.
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 material inventory was raw produce in a supermarket. Stocking up to last until next Christmas could be a bad move since perishable goods could expire or cost you storage costs. This won’t be a small error — something like this could spell the end for your business.
Without a proper raw materials inventory plan in place, your will drive up your manufacturing costs for no good reason.
Your raw materials may not spoil like supermarket produce, but the result of keeping large amounts of raw material stock around is the same. That’s why it’s important to understand your raw materials’ value and the demand from your customers.
How to calculate raw materials inventory value
Regardless of their factory floor size, manufacturers will need to account for their raw materials, business supplies, and finished products.
To do this, you’ll need to determine the ending inventory value at the end of each period. You 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. With that said, here is the raw materials inventory formula to help you calculate this:
How to calculate the raw material value with weighted average costing
Raw material costing 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%
- 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 raw materials inventory formula seems intimidating, automated solutions are available on the market. They will help you manage raw material inventory and automatically calculate your weighted inventory costs.
Best raw material inventory management techniques
When you start to optimize your raw material inventory management, here are some tips and tricks to get you started on your journey.
Don’t obsess over work-in-progress inventory
Typically, companies start with finished product inventory tracking, implement basic raw material stock management, and more complex work-in-progress management.
We strongly recommend not trying to jump to the latter immediately.
Although proper inventory management has great benefits, it also comes at a cost — the time and resources to keep it running and up to date. Thus, if possible, start with basic raw materials inventory management and do not try to track different stages of production immediately.
Just take stock of your raw materials and finished products.
It’s better to have something simple working well than something complex that does not work at all. Keep everything lean and increase raw inventory management complexity only if there is a clear business need.
Update safety stock and reorder level points
Safety stock describes the 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 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 become inconsistent.
All the events below should trigger an adjustment:
- A significant change in sales volume
- Major changes in supply lead times
- 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.
Keeping these levels up to date ensures you always have just the right amount of raw material inventory in your warehouse so that you won’t have too much cash tied up.
How much energy needs to go into raw materials inventory management
Have you heard of the Pareto Principle? The famous 80/20 rule is 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?
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 monthly. 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?” Your inventory turnover ratio (IRT) should be increased by keeping less stock. There’s no need to keep raw materials hanging around for months on end.
If your IRT is low, you could lose a good deal of money each month on carrying costs.
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, covering every aspect of your manufacturing business.
Why 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 smart because you’re prepared for anything, but in reality, it’ll weigh you down and cost more to transport.
Contrast this to a single backpack:
- You save money on baggage fees
- You can run for a bus at short notice
- It makes it easier to hitchhike
Bringing two suitcases seems less risky, but the movement is slower and 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
- Take a route that makes the most sense without disrupting plans
This type of thinking goes for keeping extra raw material inventory lying around.
Broadly speaking, as a manufacturer, you handle four different types of inventories:
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.
As the business grows, the focus might be on 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.
It seems like inventory management is taking over their life.
The business owner might spend more time managing their raw material stock with little to show. More raw materials pile up, seemingly enough to last for unforeseen occurrences. This increases your inventory expenditure on your balance sheet.
Not to mention the number of hours lost 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 what are you doing it all for if your overheads are destroying a higher percentage of your income?
Overcoming challenges with raw material data management
As you probably already gathered from this article, practicing solid raw material inventory management can be difficult.
So, before we move on to the best solution for handling your raw material, here are some things you’ll need to consider 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 ideal inventory levels.
Having the right amount of raw material stocked when needed is only possible by collecting data from your sales, production lines, and anywhere else on your supply chain. It is possible to do it with inefficient spreadsheets. However, it can be difficult 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. Due to various factors, these costs often change (meaning items in your inventory don’t have the same value as others). Tracking these costs alone will be extremely time-consuming and difficult.
Many manufacturers turn to ERP manufacturing software to help automate and track their raw inventory management software.
Use raw material management software
You could have the best managerial mind in the world.
Your industry knowledge could be second to none. But your business could still be dead in the water if you don’t have the right tools. Managing raw materials inventory in a scaling manufacturing business without dedicated software will be an uphill battle.
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 to help you with your Shopify inventory management and organize your business — including sales, supply chain management, and production.