What is Inventory Purchasing? Methods, Systems, & Accounting Tips

What is inventory purchasing?

Inventory purchasing is the process of sourcing and buying the goods and materials a company needs to sell its products. It encompasses deciding what to buy, how much to purchase, and when to place orders. 

The goal of inventory purchasing is to optimise inventory levels so that you’re in a position to meet customer demand while keeping inventory costs low. 

Inventory purchases directly impact operational efficiency and financial health by either facilitating or preventing stockouts and overstock situations – depending on how well it’s done.

Inventory purchasing differs from other types of purchasing due to its unique challenges:

• Cash flow management: Companies often delay orders when slow-moving stock ties up cash. Waiting until the last minute to place orders can lead to stockouts and lost sales.

• Data organisation: Without a centralised inventory management system, businesses struggle to make informed decisions. Cluttered data makes it challenging to plan marketing strategies or determine optimal stock levels for peak seasons.

• Reorder Point Calculation: Determining the right time to replenish stock becomes complex as the number of products increases. Managing reorder points for multiple SKUs requires careful coordination and can overwhelm businesses without proper systems.

Fortunately, various methods and systems can enhance purchasing processes, helping businesses overcome these challenges and improve inventory management.

The relationship between purchasing and inventory management

To guarantee you have the appropriate products at the right time, purchasing and inventory management must be a collaborative workflow. Effective procurement focuses on acquiring goods economically, while inventory management aims to maintain optimal stock levels.

Integrating these processes reduces extra inventory and storage costs. It also ensures product availability to meet customer demand without overstocking. You can achieve this balance through data-driven decisions about order timing and quantity – informed by information collected by your inventory management system.

The relationship between purchasing and inventory management also extends to supplier relationships. Identifying reliable suppliers who provide quality goods on time allows businesses to maintain a smooth supply chain. Such collaboration avoids wasting time, money, and resources while meeting company requirements.

How does the inventory purchasing process work?

Several steps go into inventory purchasing to ensure you always have the optimal levels stock on hand. 34% of businesses have experienced situations in which they sold an unavailable item from their inventory, creating overstock or understock issues for themselves and affecting profitability.

It is why, for most SME product businesses, the process typically follows these stages:

1. Demand forecasting: Analyse market trends and historical data to predict future demand. Accurate forecasting helps maintain optimal stock levels, preventing overstock or understock situations.

2. Identifying purchase needs: Based on forecasts and current inventory levels, determine which items need replenishment and in what quantities.

3. Creating Purchase Orders: A purchase order (PO) detailing product specifications, quantities, prices, and delivery terms is generated and sent to the chosen supplier.

4. Receiving and inspecting goods: Upon delivery, the receiving staff checks items against the PO for accuracy and quality. The supplier addresses any discrepancies.

5. Inventory reporting: Monitor purchasing and inventory costs, along with key metrics relating to supplier performance, to understand cost-effective purchasing cycles and spot inefficiencies in your workflows.

Inventory and purchasing software can automate this process, from forecasting to PO creation and inventory tracking. Cloud-based systems, such as Unleashed, can help you streamline operations, reduce errors, and provide real-time visibility into your stock levels.

Inventory purchasing systems

Inventory purchasing systems help ensure your stock levels stay at ideal levels. They support supply chain health and impact daily operations. Various approaches exist to manage inventory effectively, each with unique advantages for different business needs. 

Here are three distinct inventory purchasing systems:

1. Manual inventory purchasing system

Manual methods rely on physical counts and spreadsheets to track stock levels. Small businesses with low inventory volumes often use this method, with 38% using Excel even if over half haven’t received formal training. The system involves employees manually counting items, recording results, and entering data into spreadsheets.

While spreadsheets offer a basic, low-cost solution for inventory management, they come with limitations. Human errors can lead to costly mistakes, and the system lacks flexibility as business complexity grows. The limitations of spreadsheets include:

• Prone to data entry errors

• Time-consuming manual input and analysis

• Difficulty in scaling with business growth

• Limited real-time visibility into stock levels

• Challenges in collaboration and data sharing

2. Barcode inventory management system

Inventory systems with barcode integrations improve accuracy by using automated tracking. They use scanners and barcode inventory software to monitor goods throughout the supply chain and storage facilities.

A barcode system typically consists of the following components:

• Mobile computers

• Printers

• Handheld scanners

• Supporting software

However, barcode systems have some limitations:

• The initial cost of equipment can be high, especially for larger operations

• The learning curve for less tech-savvy staff may slow implementation

• Reliance on physical labels, which can be damaged or lost

• Scanning errors can occur due to poor label quality or incorrect placement

• Limited data storage capacity on traditional barcodes

Even with these challenges, barcode software can significantly improve inventory turnover rates by providing real-time stock levels and movement data. The information allows you to make more informed purchasing decisions and optimise inventory levels.

3. Purchase order software

Purchase order software, also known as inventory purchasing software, enables you to automate daily stock control and order management tasks while syncing live inventory data with purchasing needs. These cloud-based systems track inventory items, customer orders, and inbound deliveries to reduce costs and improve efficiency.

Key features of inventory purchasing software include:

• Real-time stock level updates

• Automated purchase order creation

• Multichannel sales tracking

• Stock-keeping unit (SKU) management

• Reporting and analytics tools

PO software also tracks parts, raw materials, and production documents throughout the supply chain for manufacturing businesses.

Unleashed offers a complete cloud-based inventory purchasing solution that centralises inventory tasks and provides instant visibility across stock and sales. 

The system updates stock levels in real time, automates purchase orders, and generates reports across multiple sales channels. These features streamline your operations, reduce labour costs, and allow you to make informed purchasing decisions.

Inventory purchasing techniques

It's important to balance client demand and supply when buying inventory. 

Various techniques let businesses manage purchased inventory efficiently. From traditional stocktaking to modern tracking methods, the right approach depends on product type, demand patterns, and budget constraints. 

You can use various methods to manage your inventory, including:

1. Reorder point method

The reorder point method optimises inventory purchasing by triggering new orders when the stock reaches a predetermined level. It helps businesses maintain adequate inventory without overstocking or running out of products.

To calculate the reorder point, use this inventory purchase formula:

[Average Daily Usage x Average Lead Time] + Safety Stock = Reorder Point

Factors influencing the reorder point include the daily usage rate, lead time for restocking, and safety stock levels.

Implementing the reorder point method in your purchase order management system can prevent stockouts, ensuring continuous sales and order fulfilment. However, its effectiveness relies on accurate calculations and up-to-date data.

Regularly review and adjust your reorder points to account for changes in demand, lead times, or other factors affecting inventory levels. Implementing the reorder point method can support balance stock levels and customer demand efficiently.

2. Economic Order Quantity (EOQ)

You can identify the appropriate order quantity with the assistance of the Economic Order Quantity formula. It balances ordering and holding costs to minimise overall inventory expenses.

The EOQ formula, developed by economist Harold A. Hotelling in 1931, is:

√{[2(Setup Costs)(Demand Rate)] / Holding Costs} = EOQ

While EOQ can reduce costs associated with buying, delivering, and storing stock, it has limitations. The formula assumes constant customer demand, ordering, and holding costs, which rarely applies to real-world scenarios.

EOQ may not provide accurate results for businesses with fluctuating demand or seasonal spikes. Companies using bill of materials in manufacturing might find EOQ less applicable due to the complexity of their inventory needs.

While it has its limitations, EOQ remains a useful tool for optimising inventory strategies when combined with other inventory management techniques.

3. Just-in-time (JIT) purchasing

The JIT approach aligns purchasing with customer demand, enabling retailers to receive goods from suppliers only when needed. Smaller, more frequent orders help achieve this goal. JIT reduces inventory holding costs, improves cash flow, and increases flexibility to adapt to demand changes.

Implementing JIT involves precise inventory management and reliable suppliers. You must closely monitor stock levels and production schedules to avoid stockouts. The COVID-19 pandemic exposed vulnerabilities in JIT systems, with many retailers facing stockouts due to supply chain disruptions, leading to overordering and subsequent excess inventory.

For manufacturers, JIT can enhance manufacturing efficiency by reducing waste and streamlining production processes. However, it requires careful coordination of production schedules and supplier deliveries. 

While JIT can optimise inventory purchasing and improve profitability, you should consider the potential risks. Implementing cloud-based inventory management software and maintaining strong supplier relationships can significantly mitigate these risks and maximise JIT benefits.

How to account for purchased inventory

Inventory purchasing involves recording acquired stock as an asset on the balance sheet. Purchased inventory increases through debits and decreases through credits. Accurate accounting enhances supply chain visibility and allows estimated cash requirements for working capital.

Best practices for inventory accounting include:

• Using appropriate cost flow assumptions to value inventory

• Implementing a perpetual inventory system for real-time tracking

• Calculating landed costs promptly with available information

The International Financial Reporting Standards (IFRS) govern inventory accounting globally. IAS 2 requires businesses to measure inventory at the lower of cost and net realisable value, ensuring accurate financial reporting and preventing stock overvaluation.

Journal entry for inventory purchasing

Recording transactions in your accounting ledger is an integral part of inventory purchasing. These entries document inventory movement through various stages, from raw materials to finished goods.

Common accounts used in inventory journal entries include:

• Inventory

• Accounts payable

• Cost of Goods Sold (COGS)

• Raw materials inventory

• Merchandise inventory

• Work-in-process inventory

• Finished goods inventory

A typical journal entry for inventory purchasing in manufacturing on credit looks like this:

It is necessary to make additional entries as the inventory progresses through the various stages of production: 

1. Moving raw materials to work-in-process

When you buy raw materials, increase your Raw Materials Inventory account and record the liability in Accounts Payable. Purchasing raw materials increases your inventory assets while creating a liability to your supplier.

2. Completing the product

As production begins, accounting transfers costs from the Raw Materials Inventory to the Work-in-process Inventory. It reflects the transition of materials into the production phase.

3. Transferring to Cost of Goods Sold when ready for sale

Once manufacturers finish production, shift costs from work-in-process to finished goods inventory. Finished goods are now ready for sale and recorded as completed products.

4. Cash sale

Recording a cash sale requires entries for revenue received and inventory reduction. The entry captures the cash payment, revenue recognition, cost of goods sold, and corresponding inventory decrease.

These journal entries for inventory purchasing support maintaining accurate records and ensure compliance with accounting standards.

Inventory purchase formula

Use the inventory purchase formula to calculate the value of purchased inventory during an accounting period.  The formula entails three key components from financial statements:

• Beginning inventory valuation

• Ending inventory valuation

• Cost of goods sold

The inventory purchase formula is as follows:

Ending Inventory – Beginning Inventory + Cost of Goods Sold = Inventory Purchases

A good example would be if a UK manufacturing company had:

• Beginning inventory = £250,000

• Ending inventory = £175,000

• Cost of goods sold = £300,000

Calculation:

(£175,000 - £250,000) + £300,000 = £225,000

The purchase amount falls below the cost of goods sold, indicating a reduction in inventory levels during the period.

Best practices for improving inventory purchasing

Strategic approaches and regular monitoring are necessary for successful inventory purchasing.  Managing purchased inventory affects both daily operations and long-term business growth. Optimising inventory processes helps maintain accurate stock levels while reducing costs. 

Here are the best practices to improve inventory purchasing:

1. Implement cloud-based inventory and purchasing software

Modern inventory and purchasing software streamlines stock management processes while reducing manual errors. Cloud-based systems track purchased inventories across locations and production stages in real-time.

Manufacturing businesses benefit from advanced features like multi-level bills of material and item-by-item cost tracking. Operations teams can create centralised production plans, assign specific tasks to employees, and monitor work orders throughout different stages.

Unleashed offers complete inventory solutions with dedicated onboarding support, extensive documentation, and multi-channel customer service. 

Users gain access to features for production management, cost tracking, and inventory control, all designed to meet the needs of small to medium-sized product-based businesses.

2. Know your supplier’s minimum order quantity (MOQ)

Minimum order quantities (MOQs) affect decisions and stock management strategies. Suppliers set MOQs to maintain profitability while efficiently managing production resources.

Products with higher manufacturing costs often have lower MOQs than easily produced items. Understanding supplier MOQs allows businesses to plan inventory levels and avoid excess stock accumulation.

Setting appropriate minimum stock levels involves analysis of sales data and lead times. Let’s say a retailer selling one item per week should order new stock when seven units remain, allowing time for delivery before depletion. Businesses should consider alternative suppliers when MOQs exceed demand requirements to prevent dead stock accumulation.

3. Know the costs of holding extra inventory

Holding costs comprise 20-30% of total inventory costs for most businesses. Smart purchasing decisions must account for storage expenses, capital, and inventory risks.

Calculating holding costs uses the formula:

[Inventory Holding Sum / Total Value of Inventory] x 100 = Holding Costs

The inventory holding sum combines several factors, including capital costs, inventory service costs, storage space expenses, and risk management costs.

Businesses with limited funds might benefit from just-in-time or economic order quantity methods. To maximise buying decisions, efficient management of holding costs calls for constant assessment of storage demands and inventory turnover rates.

4. Track inventory levels in real-time

Real-time inventory tracking enables accurate purchasing decisions through constant monitoring of stock levels. Regular audits ensure physical inventory matches reported data, which assists in avoiding understocking and overstocking events. 

Manual inventory tracking consumes significant resources, making automated solutions more efficient for purchased inventory management. Modern operations platforms streamline the process, reducing time and labour costs while maintaining accuracy.

Supply chain disruptions can unexpectedly affect purchasing patterns. Understanding supply chain connections allows businesses to anticipate and respond to disruptions, maintaining optimal stock levels regardless of the challenges.

Streamline your inventory purchasing process with Unleashed

Efficient purchasing and inventory management promote business growth by optimising stock levels and streamlining processes. Maintaining inventory efficiency calls for sturdy software and consistent monitoring. Start your free 14-day trial of Unleashed today to see how it works for yourself.