Calculating the 5 Types of Stock- From Raw Materials Inventory to WIP
There are several supply chain operations required to deliver a finished product to customers. The most complicated processes occur during production, where manufacturers handle multiple types of inventory.
Before an item is constructed, raw materials are extracted and components are manufactured to assemble the finalized product. Each of these stages requires a different type of inventory.
How to Calculate the Different Types of Inventory
As items travel through the supply chain, businesses must be able to calculate the different types of inventory to assess expenses and assets-
Raw Materials Inventory
Raw materials include the supplies needed to make a finished product, including commodities and components. These materials can be sourced naturally or manufactured externally.
In accounting, raw materials are considered inventory assets, meaning their value is added to accounts payable.
Businesses can calculate the total cost of their raw materials inventory with a simple formula-
Beginning Inventory + Inventory Purchases Ending Inventory = Total Raw Materials
For example, a manufacturer starts their quarter with $10,000 worth of inventory and purchases $15,000 worth of raw materials within the same period. At the end of the quarter, the inventory is $8,000, making the total $17,000-
$10,000 + $15,000 - $8,000 = $17,000
It is also important to note that there are two subcategories of raw materials-
Direct Raw Materials
Direct raw materials are supplies that directly make up a finalized product. For example, all of the parts needed to construct an oven, such as the metal framing, bolts, and electrical panel, are direct raw materials. These supplies are considered when calculating the cost of goods produced.
Indirect Raw Materials
Indirect raw materials are the supplies needed for the manufacturing process but aren't a part of the finalized product. Common indirect raw materials include-
- Cleaning supplies
- Disposable tools
Depending on the amount of indirect raw materials needed, businesses can report them as an expense or part of the cost of goods sold.
Maintenance, Repair, and Operating Inventory
Maintenance, repair, and operating (MRO) inventory is the supplies used to perform manufacturing operations. Typical MRO inventory includes-
- Cleaning supplies
- Training materials
Although MRO inventory makes up a significant part of manufacturers' expenses, it is often overlooked when taking count of stock. However, businesses must consider MRO inventory whenever they need to source parts for broken machinery or routine maintenance.
MRO inventory procurement is not prioritized like raw materials, as they do not need to be ordered regularly. Still, these costs can quickly add up if not handled properly. To avoid MRO pileup, companies should-
- Create a standardized MRO procurement policy
- Establish a centralized location for MRO inventory
- Negotiate supplier terms and prices each year
Work in Progress Inventory
Any product that is in the middle of being manufactured is considered work in progress (WIP) inventory, including materials currently in use on the factory floor.
WIP inventory should have its own section in the ledger to record the raw material, labor, and factory overhead costs. Calculating WIP can be challenging, as it can change at any given moment in the production schedule. Companies can designate a specific timeframe within the reporting period to count WIP.
Businesses can also avoid tedious WIP inventory counts by using the just in time (JIT) method, where stock is ordered based on real-time customer requests. This minimizes the time inventory sits on shelves in the factory, simplifying the WIP counts.
Finished Goods Inventory
Finished goods are products that are ready for sale. This type of inventory is manufactured or sourced from a supplier and ready to be distributed to customers. Once retailers purchase finished goods, it is considered merchandise.
Since finished goods usually pass through a business quickly, they are referred to as short-term assets. Even if a product line experiences an extended turnover time, retailers must note merchandise as short-term assets.
Companies can determine the value of their finished goods inventory by-
(Cost of Goods Manufactured Cost of Goods Sold) + Previous Finished Goods Inventory Value = Finished Goods
For example, a candle manufacturer reported 1,500 finished candles at the end of the previous accounting period. Each candle cost $3 to produce, making the previously finished goods inventory value $4,500-
1,500 candles x $3 = $4,500
During the following year, the company manufactured 900 more candles and sold 500 units. This makes the cost of goods manufactured (COGM) $2,700 and the cost of goods sold (COGS) $1,500-
COGM- 900 candles x $3 = $2,700
COGS- 500 candles x $3 = $1,500
Based on these values, the candle manufacturer has $5,700 worth of finished goods inventory-
($2,700 - $1,500) + $4,500 = $5,700
At the end of a reporting period, the value of finished goods, raw materials, and WIP inventory are combined to calculate the total inventory for balance sheets.
Packing Materials Inventory
Packing materials inventory includes the supplies necessary to safely pack and ship finished goods, including-
- Packing peanuts
- Bubble wrap
- Styrofoam inserts
It also includes the actual container of the item. For example, the tube that holds the product is considered part of the packing inventory rather than the finished goods inventory.
- Elements of Building a Supply Chain Strategy & 6 Ideas
- How to Correct Inventory Errors in Financial Statements
- 5 Ways to Improve Product Availability and Banish Stockouts
- What is Consigned Inventory? Pros vs. Cons and Best Practices
- How to Improve Supplier Quality Management- 6 Best Practices
- Calculating the 5 Types of Stock- From Raw Materials Inventory to WIP
- Product Line Extension- 5 Things to Consider