Manufactured items need many parts which need to be purchased. Consider a wristwatch as an example. Although it may look simple on the outside, disassembling it reveals several components necessary for the watch to function properly.
The price of a product influences how much it costs to produce it (e.g., raw materials, labor, and production). Understanding your work in process inventory for inventory accounting is crucial.
In any production round, partially finished items are referred to as “work in process” (WIP) inventory. In production and supply chain management, the entire cost of unfinished goods is called work in process.
A work-in-process inventory is any raw material stock that has undergone manual labor but has yet to be categorized as a finished good. WIP inventory isn’t completed product stock but is not made of raw materials either. Because of this, Work-in-Process inventory is part of the manufacturing inventory.
A company that buys finished goods directly from a supplier or manufacturer is less likely to manage the WIP inventory process. It’s different for businesses that sell highly customized products, such as handmade goods.
The Importance of Work-In-Process Inventory
The movement of manufacturing costs from one production stage to another is known as the WIP. The sum under Work-in-Process Inventory also includes all production expenses you incurred for incomplete or unfinished goods. Raw materials, labor utilized to make completed goods, and overhead expenses are all included in production costs.
You can categorize an item inventory as work-in-process inventory if it includes human labor. In any case, it shouldn’t get to the point of finished goods. Additionally, it can consist of a small amount of necessary work, not the entire project. Companies can use various accounting techniques to estimate the value of work-in-process inventory. Just like they can for other inventory accounts.
On a merchant balance sheet, the following make up the inventory line item:
- Raw Materials – The materials used to assemble your product
- WIP Inventory – These goods are currently going through one or more stages of production. It can’t be sold since they are still incomplete.
- Finished Goods – These are the completed goods you have assembled and are ready for sale. Once it’s sold, they are classified as merchandise. Any related costs are moved to the Cost of Goods Sold (COGS) in the accounting ledger.
Therefore, the total value of all unfinished products is considered Work-in-Process inventory for accounting purposes. Although you can’t sell these goods, include them as an asset on your balance sheet. WIP inventory should also be an asset when determining your company’s value to attract investors or obtain funding. Accounting-wise, figuring out WIP inventory helps determine your inventory’s actual value for tax considerations.
Additionally, figuring out your WIP inventory gives you a clear picture of the state of your supply chain. This data allows you to improve supply chain planning. Carrying minimal WIP Inventory is ideal. When you have too much WIP inventory, your manufacturing or purchasing process can suffer multiple bottlenecks.
Calculating Work-in-Process Inventory
Associating a cost with a completion percentage is required to determine the value of WIP inventory.
The total WIP inventory amount represents the ending work in process inventory for one accounting period and the starting work in process inventory for the following accounting period. This ending inventory amount is a current asset on a balance sheet.
The formula for the calculation of the Work-in-Process inventory is as follows:
Ending WIP Inventory = (Beginning WIP Inventory + Manufacturing Costs) – Costs of Goods Manufactured (COGM)
All expenses related to producing a finished good are included in your manufacturing costs. It covers the price of labor, overhead, and raw materials (or production inventory). The cost of labor and raw materials will increase with more Work-in-Process inventory, affecting the overall cost of manufactured goods.
COGM includes all expenses incurred to produce a completed well. To determine the worth of your current WIP inventory, you must know the final COGM. You get COGM by adding your starting WIP inventory to the manufacturing costs. The ending WIP inventory is then subtracted, giving you the final cost of manufactured goods.
To illustrate these calculations, suppose your company has around $20,000 WIP going into 2023. Your previous accounting record determines this. Once January 2023 comes around, your business will spend about $250,000 on manufacturing costs. The cost of finished goods comes in at $200,000. Let’s calculate using the formula stated above:
($20,000 + $250,000) – $200,000 = $70,000
We’ll end up with $70,000 for our ending Work-in-Process inventory.
Although “work in process” and “work in progress” are sometimes used interchangeably, their meanings might vary by industry. Raw materials that are quickly transformed into final items in inventory are called “work in process.”
On the other hand, “work in progress” is frequently used in construction and other service-related industries. It describes the status of a project and its cost with its progress. Both phrases have the same meaning when companies sell tangible goods.
Understanding Work-in-Process Inventory for Your Supply Chain
Most eCommerce companies depend on a manufacturer or supplier for their sellable goods. It’s crucial to understand the procedure and flow of WIP inventory. It can reveal how effectively your supplier or manufacturer produces finished goods. You can identify methods to optimize the supply chain by cooperating closely with your supplier and other partners in your retail supply chain. This includes third-party logistics (3PL) businesses.
WIP inventory is an inventory asset. You must account for it on your company’s balance sheet to avoid an undervaluation of your overall inventory. The price of your finished goods could increase as a result. To accurately determine the value of your inventory for tax purposes, it is best to track WIP inventories.
For supply chain managers, growing WIP inventory levels should be closely monitored. A significant WIP inventory level may indicate bottlenecks in your manufacturing process and that the process needs fixing. You must identify and resolve these issues before they harm your bottom line.
Accurate inventory accounting helps your company with budgeting and planning for the future. It also lets you assess if your company’s current marketing initiatives are hitting the right objectives.
It’s best to monitor your accounting. It can quickly identify irregularities in your cash flow that could have stemmed from fraud, carelessness, or waste. Additionally, you can examine transactions that occur between the company’s checking account and bank account. Furthermore, accurate inventory accounting lets you compare costs and revenues coming into your company.
Fraud can impact everyone. You can lose trust and clients. Additionally, it can cost more time and resources to convince your stakeholders and clients that you are viable.
Properly tracking your WIP inventory can assist your company in developing, maintaining, and managing budgets. Also, you can easily comprehend when and how cash enters and leaves your business. Furthermore, it can assist in making plans for additional financial reserves to help your company weather unforeseen circumstances.
A company’s sustained WIP inventory significantly impacts how much its business is worth. This factor is also something banks and lenders look at when you’re applying for a loan. While WIP is considered a current asset, it isn’t particularly liquid and isn’t immediately available for sale. WIP inventory doesn’t count as collateral by loan companies.
Having a stable work-in-process inventory doesn’t mean seeing big numbers. It is better to measure consistency in terms of sales. Your production processes should run smoothly if your WIP inventory is stable or decreases without affecting sales. But if it keeps growing without an increase in sales, it means production inefficiency. Consider optimizing your shipping and fulfillment to boost your profits. Route optimization for delivery is a great way to do so.
You can uncover ways to optimize your supply chain to generate greater profits by understanding work-in-process inventory. Better insights translate into better judgments when it comes to inventory management. You can’t afford to base your plan just on conjecture. Having the appropriate tools and building the ideal inventory management system is best.
Growing a profitable online store requires careful inventory management. Work with a 3PL that can offer the services, technology, data and analytics, and experience you need to help you make better business decisions.
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