Work in process (WIP) inventory refers to materials that are waiting to be assembled and sold. WIP inventory includes the cost of raw materials, labor, and overhead costs needed to manufacture a finished product.
Since WIP inventory takes up space and can’t be sold for a profit, it’s generally a best practice for product-based businesses to minimize the amount of WIP inventory they have on hand.
In this article, we’ll cover the importance of classifying WIP inventory, how to calculate it, and how you can use the insights to optimize your inventory management . But first, let’s start with the basics.
What is work in process inventory?Work in process inventory encompasses all inventory types in the intermediate stage between raw materials inventory and final products. If raw material is combined with direct labor but is not ready to be sold, it counts as WIP inventory. For example, if a company sells bags of coffee, their WIP inventory would include bags, labels, coffee beans, and shipping boxes.
Work in process vs. work in progress inventoryThese two terms are interchangeable, for the most part. However, some supply chain managers might use work in process in the context of production operations that can be completed in a short period of time (like our coffee example above) and use work in progress for large-scale productions like construction projects.
Both terms can be abbreviated as WIP inventory.
To clarify where WIP inventory falls in the production process, let’s look at it in the larger context of other inventory classifications. All of the following terms are under the umbrellas of manufacturing inventory.
Now that you’ve got a grip on what WIP inventory is, you might be wondering why it’s important to classify in the first place.
While work in process and finished goods refer to various stages in an inventory’s life cycle, they have clear distinctions.
Work in process inventory is the stage immediately before it becomes a finished good. They aren’t yet ready for sale and are still listed under the inventory asset account in a company’s balance sheet. The inputted value of work in process inventory is often not the final amount, as other costs for packaging, storage, and transportation are also added in later steps.
When inventory has undergone full production and is in a stage that’s ready for sale, it becomes a finished good in inventory accounting . The total value is transferred to the company’s finished goods account and then later to the cost of sales.
Now that you’ve got a grip on what WIP inventory is, you might be wondering why it’s important to classify in the first place.
Why is it important to classify work in progress inventory?Taking time to classify WIP inventory in a warehouse waiting to be assembled might seem tedious, but it’s crucial for monitoring and improving your supply chain and inventory control.
As we mentioned earlier, holding on to excessive WIP inventory is usually not beneficial for a business's bottom line. There are a few reasons for this:
Another reason to classify WIP inventory is that it’s a significant factor in the valuation of your business. If you’re applying for a loan, the lender may be hesitant to count WIP inventory as collateral (even though it’s tallied as an asset) since it’s not very liquid.
If you’ve never calculated WIP inventory, here’s how you can start.
How to calculate work in process inventoryCalculating the value of WIP inventory involves associating a cost with a percentage of completion. This can be a bit time-consuming, so it’s typically best to tally it up at the end of your accounting period to minimize uncertainty on your company’s balance sheet. Here’s a step-by-step guide to help you through the process.
Ending WIP Inventory = (Beginning WIP Inventory + Production Costs) – Finished Goods Cost
WIP inventory formula in action:
Suppose you start the year with $10,000 in beginning WIP inventory. You incur $300,000 in production costs. The cost of finished goods produced is $250,000.
Your WIP inventory formula would look like this: ($10,000 + $300,000) – $250,000 = $60,000
Work in process inventory = $60,000
By following these steps, you can systematically calculate your WIP inventory and have a clearer understanding of your production process and current assets.
Also, different sectors or businesses might use more complex or slightly altered approaches to calculate WIP inventory. For the most precise and current guidance on calculating WIP inventory, particularly for specialized industries or intricate production processes, it is advisable to consult with a certified accountant or review the latest accounting standards and guidelines.
WIP is classified as a current asset on the balance sheet and resides under the inventory section. The significance of WIP levels depends on the industry and specific business context.
High WIP Levels:
Low WIP Levels:
Businesses should monitor their WIP levels carefully, analyzing the underlying causes of fluctuations to make informed decisions about production, inventory management, and resource allocation. Keep in mind that WIP interpretations can vary depending on the company and sector. Consulting with an accountant is advised to ensure accuracy when assessing implications.
Tracking work in process inventory is essential for understanding your manufacturing or production costs, managing resources efficiently, and ensuring a smooth workflow. Here are a few effective methods you can use:
Pros: Simple, low-cost, and easy to set up.
Cons: Can become complicated and prone to errors as your business grows.
Pros: Offers greater accuracy, automation, and scalability compared to spreadsheets.
Cons: Can be more expensive, and may require a learning curve.
Pros: Offers a complete overview of your manufacturing process, enabling data-driven decisions and optimization.
Cons: More costly, suitable for larger businesses with complex production processes.
Pros: Simplifies tracking, reduces errors, and provides real-time data.
Cons: Requires an initial investment in hardware and software.
Pros: Provides detailed cost information for each product or project.
Cons: Can be time-consuming for large-scale production.
Tips for effective WIP tracking:
By implementing effective WIP tracking, you can gain valuable insights into your production process, optimize your operations, and improve your bottom line.
Properly managing your work in process inventory can significantly benefit your business by improving efficiency, profitability, and overall operations. Let’s break down the advantages:
By monitoring WIP closely, you can identify and address production line bottlenecks. This contributes to smoother operations, reduced lead times, and ultimately, faster delivery of finished products to your customers.
Excess WIP ties up valuable resources and increases storage costs. With efficient WIP management, you can minimize waste, optimize inventory levels, and lower your overall production expenses.
Understanding your WIP status allows you to allocate resources—whether labor, materials, or equipment—more effectively. This prevents overallocation in one area while neglecting another, leading to a more balanced and efficient production process.
Regularly reviewing WIP enables you to catch potential quality issues early on. By addressing these problems before they escalate, you can avoid costly rework and ensure that your final products meet the highest standards.
Correct tracking ensures accurate inventory valuation, which in turn leads to more reliable financial reporting and better decision-making.
Clear insights into your WIP levels and production cycle times allow for more reliable forecasts and production plans. You can anticipate demand, adjust production schedules accordingly, and avoid overproduction or shortages.
Efficient WIP management translates to faster turnaround times and consistent product quality. This ultimately leads to happier customers, repeat business, and a stronger brand reputation.
Get a more accurate value of your businessSince WIP inventory is an inventory asset, neglecting to include it on your business’ balance sheet can cause your total inventory to be undervalued. As a result, the cost of your finished goods will be overstated. For tax purposes, it’s best to track WIP inventory to get an accurate breakdown of what your inventory is actually worth.
Some companies do a physical count of their WIP inventory to determine the value based on the current stage of each unit in the manufacturing process. This eats up huge amounts of valuable time and distracts your team from doing higher-level work. Establishing ongoing WIP tracking systems is more efficient.
Optimizing your work in process inventory is important for enhancing efficiency, reducing costs, and improving overall productivity in your business. Let’s look at how you can achieve this:
When it comes to inventory management, better insights mean better decisions. You can’t afford to leave your strategy to guesswork. But in order to build the optimal inventory management system, you need the right tools.
QuickBooks Enterprise is a complete solution for inventory management, offering everything from one-click processing and mobile scanning to inventory analysis and reporting. It has everything you need to keep your products, customers, and transactions synced and secure, freeing you up to focus on your business.
Using inventory types & classifications to boost your bottom line
January 16, 2024
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