Understanding Inventory
Read this section, which focuses on the nature of inventory, categories of goods included in inventory, components of inventory cost, and the flow of inventory costs.
Categories of Goods Included in Inventory
Most manufacturing organizations usually divide their “goods for sale” inventory into raw materials, work in process, and finished goods.
LEARNING OBJECTIVES
Distinguish between the raw materials, work in process, finished goods, and goods for resale
KEY TAKEAWAYS
Key Points
- Raw materials – Materials and components scheduled for use in making a product.
- Work in process /progress (WIP) – Materials and components that have began their transformation to finished goods.
- Finished goods – Goods ready for sale to customers.
- Goods for resale – Returned goods that are salable.
- Distressed inventory is inventory for which the potential to be sold at a normal cost has passed or will soon pass.
- Inventory credit refers to the use of stock, or inventory, as collateral to raise finance.
Key Terms
- work in progress: A portion of inventory that represents goods which are no longer salable as raw materials, but not yet salable as finished goods.
- Work in process: a company's partially finished goods waiting for completion and eventual sale or the value of these items
- Finished goods: Goods that are completed, from a manufacturing standpoint, but not yet sold or distributed to the end-user.
- finished goods inventory: the amount of completed products not yet sold or distributed to the end-user
- raw materials: A raw material is the basic material from which a product is manufactured or made.
Categories of Goods
While the reasons for holding stock were covered earlier, most manufacturing organizations usually divide their “goods for sale” inventory into several categories:
- Raw materials – Materials and components scheduled for use in making a product.
- Work in process or work in progress (WIP) – Materials and components that have began their transformation to finished goods.
- Finished goods – Goods ready for sale to customers.
- Goods for resale – Returned goods that are salable.
Raw Materials
A raw material is the basic material from which a product is manufactured or made. For example, the term is used to denote material that came from nature and is in an unprocessed or minimally processed state. Latex, iron ore, logs, crude oil, and salt water are examples of raw materials.
Work in Process (WIP)
WIP, or in-process inventory, includes unfinished items for products in a production process. These items are not yet completed, and are just being fabricated, waiting in a queue for further processing, or in a buffer storage. The term is used in production and supply chain management.
Optimal production management aims to minimize work in process. Work in process requires storage space, represents bound capital not available for investment, and carries an inherent risk of earlier expiration of the shelf life of the products. A queue leading to a production step shows that the step is well buffered for shortage in supplies from preceding steps, but may also indicate insufficient capacity to process the output from these preceding steps.
Finished Goods
Goods that are completed (manufactured) but not yet sold or distributed to the end-user.
Goods for resale
Returned goods that are salable. This is not always included in the “goods for sale” inventory; that depends on the preference of the company.
Example
A canned food manufacturer's materials inventory includes the ingredients needed to form the foods to be canned, empty cans and their lids (or coils of steel or aluminum for constructing those components), labels, and anything else (solder, glue, etc.) that will form part of a finished can. The firm's work in process includes those materials from the time of release to the work floor until they become complete and ready for sale to wholesale or retail customers. This may be vats of prepared food, filled cans not yet labeled, or sub-assemblies of food components. It may also include finished cans that are not yet packaged into cartons or pallets. The manufacturer's finished good inventory consists of all the filled and labeled cans of food in its warehouse that it has manufactured and wishes to sell to food distributors (wholesalers), to grocery stores (retailers), and even perhaps to consumers through arrangements like factory stores and outlet centers.