Getting to know work in process (WIP) inventory
Work in process is a crucial stage in the production process where a manufacturer converts raw materials into finished items. The business needs to maintain an accurate record of assets on the balance sheet – and so work in process inventory is necessary.
If that sounds complicated, don’t worry – it doesn’t have to be. With the right tools and methods, any business operator can get a handle on it.
By the end of this guide, you’ll understand what work in process inventory is, why it’s important to calculate it, how it differs from work in progress, and how you calculate it.
Work in process inventory, or WIP inventory, shouldn’t be confused with work in progress meetings or updates, as used in general business and project management.
What is work in process (WIP) inventory?
Work in process (WIP) inventory refers to partly finished goods that come in between raw materials and final products in the production process. Raw material that's combined with direct labour but not yet ready to be sold counts as WIP inventory.
For example, the WIP inventory of a coffee company might include coffee beans, packaging, labels and shipping boxes.
WIP inventory costs include all raw material costs related to the final product, plus direct labour and overhead costs. Because of this, many companies only calculate the value before a reporting period.
WIP inventory is considered an asset on a company’s balance sheet and is one of 3 main types of inventory along with raw materials and finished goods.
Raw materials inventory refers to the raw materials that you need to produce your products. For example, if you manage an ice cream business, raw materials could include milk.
Finished goods inventory refers to finished products that are ready to sell.
What’s the difference between work in process and work in progress?
Both work in process and work in progress can be abbreviated as WIP which can make it confusing if they’re used interchangeably.
Generally, work in process refers to manufactured products that move from raw materials to finished products quickly. For example, a bakery with 50 batches of bread in production is a work in process.
On the other hand, work in progress may refer to large-scale productions that take longer to complete. For example, a construction project with 3 floors out of 25 completed is a work in progress.
Work in progress is often used in services and consulting businesses to describe the status of tasks and projects.
Why do you need to calculate WIP inventory value?
Although it can be tricky, there are several reasons you need to calculate your WIP inventory value. For starters, accurately calculating your WIP inventory it'll keep your balance sheet updated with the different types of inventory and not just the goods sold.
Additionally, if you offer customised products, understanding your WIP inventory is more crucial. You learn what goes into the production cost and how to calculate it at the end of the accounting period. Plus, it gives you an idea of the cost of goods sold (COGS).
Identify production bottlenecks
One of the major benefits of calculating your WIP inventory is that you can identify production bottlenecks. As a result, you can immediately improve the production process by resolving those issues sitting as roadblocks in the process.
You can use WIP days – that is, the average number of days that you can afford to keep units or jobs in progress before they are completed and delivered to customers – to identify production bottlenecks:
WIP days = Total Current WIP Used / Total Production Cost x No. of Days
For example, 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.
In other words, units or jobs should be ongoing for an average of 156 days. If you exceed that, you might not be able to sell the finished goods because your customers looked elsewhere. So to avoid any production bottlenecks, avoid taking on too many jobs.
More accurate business valuation
WIP inventory is a business asset. If you don’t calculate your WIP inventory, you might undervalue your inventory. Consequently, the cost of goods manufactured will be exaggerated and will directly impact your bottom line. Therefore, calculating your WIP inventory gives you a more accurate business valuation.
Another reason you should keep your WIP at minimal levels is to keep the associated costs low. You need storage and warehousing plus various utilities like electricity and staffing to "preserve" any type of inventory, including WIP until it's complete.
How do you calculate WIP inventory value?
As mentioned earlier, calculating your WIP inventory value is more complex than determining the value of finished goods because there are more moving parts.
Here are 3 terms to keep in mind:
Beginning WIP inventory cost
The beginning WIP inventory cost refers to the asset section of the balance sheet from the previous accounting period.
To calculate the beginning WIP inventory, take the ending WIP inventory figure from the previous period, and carry it over as the beginning figure for the new accounting period.
Manufacturing costs cover all the costs associated with manufacturing a finished product, including raw materials, labour and overhead costs. The more WIP inventory you have, the higher the raw materials and labour, which impacts the cost of the finished goods. The formula used is:
Manufacturing Costs = Raw Materials + Direct Labor Costs + Manufacturing Overhead
Cost of manufactured goods (COGM)
The cost of manufactured goods (COGM) 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 WIP inventory value.
The COGM is calculated by adding the total manufacturing costs to your beginning WIP inventory and then subtracting the ending WIP inventory. The formula used is:
COGM = Total Manufacturing Costs + Beginning WIP Inventory – Ending WIP Inventory
Once you’ve calculated your beginning WIP inventory, your manufacturing costs, and your cost of manufactured goods, you can easily calculate your WIP inventory value as follows:
Ending WIP Inventory = Beginning WIP Inventory + Manufacturing Costs – COGM[TM4]
WIP inventory examples
Let’s take a look at a couple of WIP inventory examples to see the formula in action.
WIP inventory example #1:
If your business calculates WIP inventory at the end of each quarter, and your accounting records show that your ending WIP inventory for the previous quarter was $15,000, that will be your beginning WIP inventory for the current quarter.
During the quarter, you invested $225,000 in production costs, and the total value of your finished goods is $215,000.
Therefore, your ending WIP inventory is calculated as follows:
Beginning WIP Inventory + Manufacturing Costs – COGM = Ending WIP Inventory
$15,000 + $225,000 – $215,000 = $25,000
So, your ending work in process inventory is $25,000.
WIP inventory example #2:
For a more in-depth example, let’s say you run a shoe brand with a beginning WIP of $100,000. In the new year, you spend $150,000 on manufacturing costs. You also manufacture 5,000 pairs of shoes, each costing around $30 to produce on average, which means your cost of manufactured goods is $150,000.
Next, you calculate your ending WIP inventory value:
Beginning WIP Inventory + Manufacturing Costs – COGM = Ending WIP Inventory
$100,000 + $150,000 – $150,000 = $100,000
So, your ending work in process inventory for the year is $100,000.
How do you reduce work in process inventory?
You can reduce your work in process inventory by adjusting your manufacturing processes, investing in employees, and using inventory management software.
Use Just in Time (JIT) manufacturing
Just in time (JIT) manufacturing is a production method where materials are only brought in and used as they are required. JIT is an excellent way to reduce several types of waste, including overproduction, waiting and surplus inventory. As a result, you have a faster turnover and less money tied up in materials.
Identify bottlenecks in the manufacturing process
A bottleneck slows down the manufacturing process and may require employees to work overtime or sacrifice other tasks. But removing bottlenecks reduces the work in process time and maximises output. You can usually remove bottlenecks by allocating more resources (employees or materials) to the problematic stage.
Upgrade your machinery and workforce
Upgrading your machinery and workforce are two of the best ways to reduce WIP in a manufacturing environment. The best option is to offer in-depth training sessions and instructions on how to perform tasks so that employees master their trade. But you also need to upgrade their tools if you want to reduce WIP inventory. Other options include hiring more employees, offering incentives and fixing machinery.
Use inventory management software
Using inventory management software helps you record and maintain accurate inventory cycle counts, which keeps WIP inventory low. Having accurate, real-time inventory counts enables you to forecast accurately and communicate with suppliers and freight forwarders more efficiently. Inventory management software optimises your WIP inventory flow.
Is raw material considered work in process?
No, work in process starts when human labour interacts with the raw material.
How do you find beginning work in process inventory?
The beginning work in process inventory cost is the same as the ending work in process inventory figure for the previous accounting period (quarter, year, and so on). Simply carry it over as the beginning figure for the next accounting period.
What is “just in time” inventory management?
Just in time (JIT) inventory management is a fluid process that ensures you're using materials as they arrive so that it reduces storage burden and ensures materials aren't wasted.
Where do I account for WIP inventory on my balance sheet?
WIP inventory is included in the inventory line item as an asset on your balance sheet. The two other types of inventory are raw materials (the beginning materials used to manufacture a product) and finished goods (the fully assembled products ready to be sold).
Is WIP inventory subject to taxes?
Yes, WIP inventory is considered a current asset and subject to taxes, which is why you should keep it as low as possible and make sure you value it correctly.
What tools do I need to calculate WIP value?
Calculating your WIP value is a time-consuming process, so it’s easier and more efficient to use inventory management software. MYOB software helps businesses of all sizes effortlessly manage inventory.
Reduce work in process inventory with MYOB
MYOB offers robust inventory management and warehouse management solutions to help you identify production bottlenecks, calculate a more accurate business valuation and reduce your WIP inventory.
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