Question

Question 1
You work for ABC Ltd that is a fast-growing local organic fruit juice manufacturer. Since starting operations, ABC has been struggling to become profitable. After careful analysis, you found that this issue might rest with the way it accounts for inventory.
One definition of inventory according to Will Kenton, “Inventory” Investopedia, is: the raw materials, work-in-process goods, and completely finished goods that are considered to be the portion of a business’s assets that are ready or will be ready for sale.

(a) Discuss why inventory are needed at all. Provide an example for each of your reasons.
(16 marks)

Answer 1

An Operating cycle of a business consists of purchase of raw material, converting them into finished goods and selling them to customers and then converting to cash. At various stages of a production cycle inventory is carried so that the production meets the demand requirement in the market. Accordingly inventories are carried by business depending on various factors like safety stock, re-order level, work in process depending on manufacturing process, customer demand for finished goods, etc. Let us analyse inventory by components to understand it better

• Raw Material: A firm buys required raw material from the vendors. Since this is the basic requirement for production firm defines the safety stock which it will carry along with re-ordering level to ensure there is no stock out and production does not hamper. Hence firms carry raw material inventory all the time in its manufacturing cycle
• Work in process: A manufacturing firm which manufactures product based on process flow will have some component in work in process (consists of raw material, direct labor and manufacturing overheads) and this will be accounted as part of its Inventory at the year end
• Finished Goods : When a firm manufactures Finished goods to its customers it will always have some Finished goods in hand to ensure no stock out and loss of sales based on demand of customers

All inventories are reported as Current Assets and is part of working capital of the firm