In the dynamic landscape of the supply chain industry, efficient management of inventory stands as a cornerstone for operational success. One of the types of inventory-WIP inventory or in-process inventory is a critical and intricate type that is extremely important for supply chains.
Work-in-progress inventory refers to partially completed goods in various stages of production. It includes the transition from raw materials to finished products. Understanding WIP inventions involves recognising its pivotal role in streamlining production processes, optimising resource allocation and enhancing overall operational efficiency.
Moreover, grasping its significance entails a comprehension of its implications on cash flow, lead times, and customer satisfaction. So, we will dissect the nuances of the Work in Progress inventory, shedding light on its multifaceted nature and unveiling strategies for effective management.
WIP’s Role in the Production Cycle and Financial Reporting
At this stage, these inventory items are not marketable and require more time before companies can sell them on the market. The term implies that the goods are partially completed and in the production cycle.
For instance, the inventory for WIP could be undergoing finishing touches before being marked as complete. There are three stages to such inventory- a current asset on the balance sheet-it can have the following classifications:
- Raw Materials: These are the foundational materials utilised in the production process, typically commodities or basic components awaiting transformation.
- Work In Progress (WIP): At this stage, the conversion of raw materials into finished goods has commenced, but the product is not yet finalised for sale.
- Finished Goods: The items have completed the manufacturing process and are ready for sale.
On the income statement, the sale of the product lies under the cost of goods sold (COGS) line item. To do so, we need to calculate the inventory statistics.
WIP Inventory Calculation
The formula for calculating inventory for WIP management-specifically in the context of a manufacturer- is as follows:
Ending Work in Progress=Beginning WIP + Manufacturing Costs – Cost of Goods Manufactured
The beginning work in progress inventory is the ending balance from the prior accounting period, i.e. the closing carrying balance carries forward as the beginning balance for the next period.
The manufacturing costs are then added to the beginning balance. Manufacturing costs encompass expenses associated with transforming raw materials into finished goods, including raw materials, labour, and overhead costs.
The formula for manufacturing costs is:
Manufacturing Costs = Raw Materials + Direct Labor Costs + Manufacturing Overhead.
In the final step, the Cost of Goods Manufactured (COGM) is calculated by subtracting the cost of ending Work in Progress (WIP) inventory from the total manufacturing costs
COGM = Manufacturing Costs + Beginning WIP Inventory – Ending WIP Inventory
Calculating Work in Progress inventory value is crucial for maintaining an accurate balance sheet and understanding production costs. It provides insight into the composition of inventory beyond goods sold and is especially important for businesses offering customised products.
The Role of Work in Process Inventory in the Supply Chain
Even though you cannot see inventory, it is still an asset on the balance sheet. For this reason, it’s best to hold as little inventory as possible.
An excess of inventory can cause bottlenecks within the supply chain. Here’s the solution:
Store inventory for WIP somewhere, and hold unsellable inventory for an extended period. This will increase inventory carry costs and drag down profitability. Free up storage space for finished goods that are ready to create revenue.
The inventory represents capital that is tied up in raw materials and overhead costs. Holding as little inventory as possible means you’re putting your capital back to work for you in the form of finished goods. Unfinished products are at higher risk for loss or damage in the process.
All the functions of the work-in-progress inventory have significant advantages for the supply chain on a large scale. Let’s see them in detail.
3 Benefits of WIP Inventory
Here are the benefits that companies can harness when they invest in inventory for their “work in progress” materials and goods:
- Identify Production Bottlenecks
One of the major benefits of calculating inventory is that it helps to identify production bottlenecks. As a result, you can immediately improve the production process by resolving those issues that create the bottlenecks in the first place.
You can use WIP days- which refer to the average number of days that you can afford to keep units or jobs in progress. They can do so before they complete and/or deliver it to the customers- to identify production bottlenecks.
WIP days = Total Current WIP Used / Total Production Cost x No. of Days
For instance, let’s say the total production cost is $3,000,000 and you operate for 360 days a year. So far, the total equals $1,300,000, so the WIP days equal 156 days.
- Enhanced Business Valuation Precision
Work-in-progress (WIP) inventory stands as a critical business asset. Neglecting its calculation could lead to undervaluing your overall inventory. This oversight inflates the cost of goods manufactured, directly impacting your bottom line. Hence, accurate Work in Progress inventory assessment ensures a more precise business valuation.
- Minimisation of Waste
Maintaining minimal levels of Work in Progress inventory is essential to curbing associated costs. This includes expenses related to storage, warehousing, as well as utilities such as electricity and staffing required to manage and preserve any inventory, including WIP, until its completion.
Knowing the benefits of the Work in Progress inventory, you would want to calculate it as well. Let’s see how that is possible.
Method to Calculate Work-in-Progress Value
As mentioned earlier, calculating inventory value for WIP is a more complex process than determining the value of the finished goods. This is because there are more moving parts.
Here are 3 things to keep in mind:
Beginning cost of inventory: This refers to the asset section of the balance sheet from the previous accounting period. To calculate it, take the figure from the previous period and carry it over as the starting figure for the new accounting period.
Manufacturing Costs: This covers associated costs that come with manufacturing a finished product. They include raw materials, labour and overhead costs. The more inventory, the higher the raw materials and labour which impacts the cost of the finished goods. Here is the formula to calculate it:
Manufacturing Costs= Raw Materials+Direct Labour Costs + Manufacturing Overhead
To calculate the value of the inventory of WIP you need to know the cost of the manufactured goods.
Cost of Manufactured Goods (COGM)
This refers to all the costs incurred to make a final product. You need to know the final COGM to calculate the value of your current Work in Progress inventory value.
You can calculate the COGM by adding the total manufacturing costs to your beginning inventory and then subtracting the ending inventory for WIP. The formula for it is:
COGM = Total Manufacturing Costs + Beginning WIP Inventory – Ending WIP Inventory
Once you’ve calculated your beginning inventory, your manufacturing costs, and your cost of manufactured goods, you can easily calculate your inventory value as follows:
Ending WIP Inventory = Beginning WIP Inventory + Manufacturing Costs – COGM[TM4]
Ending WIP Inventory
The final work in process (WIP) inventory represents the work amount that remains unfinished when the accounting period ends. This figure is present on the company’s balance sheet, alongside values for raw materials and finished goods.
FAQs: WIP Inventory: Meaning, Significance and Use in Supply Chain Industry
What is the WIP formula?
The formula is: beginning WIP Inventory + Manufacturing Costs – Ending WIP Inventory.
What is beginning work in process inventory?
Beginning work in process inventory refers to the value of partially completed products at the start of an accounting period. It includes costs incurred up to that point but not yet completed.
What is work in process?
Work in process is the condition of goods at various stages of completion during the manufacturing process. This represents the value of the raw materials, labour and overhead that applies to unfinished products.
Why is Work in Progress inventory significant in the supply chain?
Work in Progress inventory plays a crucial role in assessing production efficiency, monitoring work stages, and optimising inventory levels for timely order fulfilment.
Conclusion
In the supply chain industry, efficient management of inventory is paramount for success. Work in Progress inventory plays a pivotal role in streamlining production processes and enhancing overall efficiency. This helps companies to optimise their inventory levels accordingly. With experts at Qodenext, you can get the right guidance in supply chain logistics and management.
