Raw materials inventory management: Benefits and best practices

Jonny Parker
August 19, 2024

Picture a bustling pizza shop with a line of hungry customers out the door. Behind the counter are all the ingredients — flour, tomatoes, cheese, pepperoni — measured out and carefully stored. 

Effective raw materials management is what guarantees the line doesn’t run out of mozzarella during a dinner rush and the pepperoni stays nice and fresh. A well-stocked production line keeps customers happy and the shop’s reputation glowing. 

The same pressure to manage stock levels applies to manufacturers, who must master raw materials inventory management to keep production running smoothly. They need the right components in stock to prevent costly disruptions or missed order deadlines. Here’s how to better manage raw materials to elevate manufacturing operations.

What is raw materials inventory?

Raw materials inventory, also known as direct materials inventory, refers to the stock of materials a business needs for production. A business wouldn’t directly sell these materials to customers but would instead use them to manufacture the finished goods. 

After producers acquire raw materials from a supplier or manufacturer, they store those goods until they’re needed in production. As the materials move through manufacturing, they become work-in-progress inventory. Then, once completed, the final product is considered finished goods inventory, ready for sale to the end consumers or distribution to retailers. 

Businesses need to plan procurement logistics to ensure enough raw materials are on hand to meet manufacturing targets. This process includes finding the optimal amount of safety stock, which is a buffer of inventory to protect against stockouts during unexpected fluctuations in demand or supply chain disruptions.

The importance of raw materials inventory management for manufacturers

Effective management of raw materials inventory, often facilitated by dedicated inventory management software, is instrumental in creating a lean supply chain and reducing inventory costs, from sourcing to storing. Businesses can track raw material usage through an inventory account, which helps calculate the cost of goods sold (COGS) and monitor the inventory turnover ratio (which measures how often a business sells and replaces its inventory).

Here are some other benefits that highlight the importance of effective raw materials management:

  • Cost reduction: Inventory management minimizes carrying costs, reduces waste from spoilage or obsolescence, and prevents overstocking. This leads to significant cost savings throughout the manufacturing process.
  • Enhanced production efficiency: Ensuring a steady supply of raw materials helps maintain smooth production. This reduces downtime or production delays caused by insufficient materials, increasing overall operational efficiency.
  • Increased customer satisfaction: When raw materials are readily available and production stays on schedule, it leads to on-time deliveries and, ultimately, higher customer satisfaction.
  • Improved cash flow: By optimizing inventory levels, businesses free up capital that would otherwise be tied up in excess stock. An improved cash flow allows for better investments in other areas of the business, like research and development or marketing initiatives.
  • Better demand forecasting: Accurate tracking and analysis of inventory levels provide valuable data for predicting future demand, which enables manufacturers to develop more effective inventory planning and procurement strategies. That forecasting helps ensure they have the right materials available.

How to calculate raw materials inventory

If you’re trying to understand your manufacturing costs, start by calculating your stock of raw materials. Here’s how:

  1. Choose a consistent time frame: Decide on the regular interval at which you’ll count your inventory. This could be monthly, quarterly, or annually.
  2. Record your starting inventory: When you begin, carefully document the total value of all raw materials on hand. Include direct materials (those used in production) and indirect materials (like cleaning supplies).
  3. Track your purchases: Throughout your time frame, record the cost of all raw materials purchased. Include the purchase price and additional costs like shipping, handling, and taxes.
  4. Calculate the cost of material used: Determine the total cost of the materials used in production of finished goods or otherwise removed from inventory. 
  5. Apply the formula: Plug these values into the formula below to calculate your ending raw materials inventory:

Here’s the formula:

Beginning raw materials inventory + Purchases – Cost of materials used =  Ending raw materials inventory

Example:

If your beginning raw materials inventory was $10,000, you purchased $5,000 worth of additional materials, and your cost of materials used for the period was $8,000, your ending value would be:

$10,000 + $5,000 – $8,000 = $7,000

This means you have $7,000 worth of raw materials remaining for future production.

Best practices for efficient raw materials inventory management

Implementing these strategies can significantly improve raw material inventory management.

1. Accurate forecasting

By leveraging historical data and market analysis, you can better predict future demand. More accurate sales predictions mean you can maintain optimal stock levels, avoiding both overstocking and material shortages.

2. Just-in-time inventory

The just-in-time (JIT) approach involves receiving materials only when needed for production, keeping inventory costs low by minimizing holding costs and reducing waste and obsolescence.

3. Regular audits and cycle counts

Conduct regular audits and cycle counts to verify the accuracy of your inventory account to identify discrepancies early on. You can correct any errors before production shuts down.  

4. Efficient inventory tracking systems

Use an advanced inventory management software that provides real-time tracking capabilities. This grants you visibility into your raw material levels, locations, and movements, allowing for proactive management.

5. Safety stock management

Maintaining a buffer of critical raw materials, also known as safety stock, mitigates production delays caused by unforeseen supply chain disruptions. This ensures a smooth production flow despite hiccups in receiving materials.

Enhance your raw materials inventory management with Fishbowl

Tired of struggling to keep track of your raw materials inventory? Fishbowl can revolutionize the way you manage your direct and indirect materials. 

Fishbowl provides real-time visibility into your inventory accounts, empowering you to optimize stock levels and make informed decisions. By optimizing your inventory management with Fishbowl, you can reduce waste, negotiate better prices for raw materials, and ultimately lower your COGS. Book a demo to transform your raw materials inventory management today.