Finished Goods vs. Raw Materials vs. Work in Process.
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In a manufacturing environment, it’s important to distinguish between various types of inventory for financial reasons and for operational reasons. For example, if you have 5 million dollars in inventory, you would want to know how much is finished goods versus how much are materials you use to produce those finished goods. These categories are used for internal reporting purposes (financial statements and others) so It’s important those using these reports understand the categories.
First, we have Finished Goods. Finished goods includes inventory items that are in a sellable/shippable state. These are the things you manufacture that your customers buy from you.
Raw materials are the other end of the spectrum. These are materials you purchase to use in your manufacturing processes. If your manufacturing process is primarily an assembly process, you may refer to raw materials as “Components”.
Work in Process is where I run into a lot of confusion. That’s because work-in-process (WIP) means different things to different people. To accounts, WIP is the value of materials and labor that have been issued to production orders, but have not had the associated finished goods reported as produced yet. When I say “reported,” that describes the transactional process that adds the finished goods item into inventory. And the transactional process is important here since WIP is just the result of the transactions.
If you work out on the shop floor or in the warehouse, you probably don’t use this definition of WIP. In these environments, work-in-process (also called work-in-progress) refers to the physical state of inventory items. This would include items that have gone through one or more manufacturing processes, but are not yet a finished item.
There is a legitimate case to make for wanting to categorize these items based on their partially processed physical state as WIP, even though they are not part of the WIP account (as defined by the manufacturing software). Therefore, you can have an inventory Category called WIP that includes any items that have undergone some type of manufacturing but are not yet a finished good. You may even assign a specific financial account with these items and may even associate the manufacturing WIP account within this group for financial reporting purposes.
For a more detailed explanation of WIP, check out my article on WIP
Some Examples and a little confusion.
How you categorize inventory can vary by your location in the supply chain. Therefore, one company’s finished goods can be another company’s raw materials or components. For example, if you manufacture Steel, Steel (in its various forms) would be your finished goods, and ore would be your raw material. But if you manufacture warehouse rack, steel would be a raw material for you. Similarly, if you manufactured computers, a hard drive would be a component to you, but it would be a finished good at the hard drive manufacturer.
Then there are things that are used in the manufacturing process but are also sold. This is actually pretty common. A manufacturer may have items that are used in the manufacturing process, but they also occasionally sell them to support servicing/repairing of the main product they sell. In this case, you would probably categorize them based on their primary use (how you use most of them); therefore, you would likely categorize them as raw materials/components. Remember, these categories are used for internal reporting, so make sure there is no confusion as to what they include.
Other classifications for WIP items.
Other terms often used for these classifications would include Unfinished Goods, Semi-finished Goods, Subassemblies, or possibly terms that relate to a specific characteristic based on your manufacturing processes, such as Blanks, Castings, Sheets, Bar Stock, Machined Goods, Die Cuts, etc.
Some of these categories may be subcategories of higher-level inventory categories. The point here is to use them where they may affect decisions. If knowing how much inventory you have that are castings is useful in making decisions, find a way to use the category; if not, don't.
You may also want to check out my article on Inventory versus Non-inventory
More Articles by Dave Piasecki.
© Copyright. Content on InventoryOps.com is copyright-protected and is not available for republication.
Dave Piasecki, is owner/operator of Inventory Operations Consulting LLC, a consulting firm providing services related to inventory management, material handling, and warehouse operations. He has over 25 years experience in operations management and can be reached through his website (https://www.inventoryops.com), where he maintains additional relevant information.
