In manufacturing and fulfillment, every stage of production matters. But there’s one critical phase that often doesn’t get the attention it deserves: work in process (WIP) inventory.
WIP inventory refers to the partially completed products in your production line, representing the materials and effort you’ve invested before the items are ready for sale.
Understanding and optimizing WIP inventory can improve your operations, cash flow, and production costs.
Keep reading to learn all about WIP inventory and how it can transform your business operations.
TL:DR:
Key takeaways
Work in process inventory represents partially completed products in production, including raw materials, labor costs, and overhead.
WIP inventory is calculated using the formula: Beginning WIP inventory + Manufacturing Costs – Cost of Goods Manufactured = Ending WIP inventory.
WIP is reported as a current asset on the balance sheet and affects the cost of goods sold on the income statement.
Excess WIP can lead to cash flow strain, increased storage costs, risk of obsolescence, and concealed inefficiencies.
The aim is to optimize, not eliminate, WIP inventory to balance smooth production flow with minimal tied-up capital.
Implement just-in-time production, use inventory management software, and regularly review WIP levels to optimize inventory.
Definition of WIP inventory
Work in process inventory, also referred to as progress inventory and work in progress inventory, represents the value of partially completed products in your production cycle.
WIP inventory includes:
Raw materials that have entered the production process
Direct labor costs associated with these partially completed goods
Allocated manufacturing overhead costs
WIP inventory is more than just unfinished products—it provides a snapshot of your production efficiency and a significant portion of your working capital.
NOTE: WIP inventory is distinct from raw materials inventory, which consists of unused materials that have not yet entered production.
Which businesses should calculate WIP inventory?
Businesses likely to have significant WIP inventory are typically those with complex manufacturing processes, long production cycles, or those creating custom or highly specialized products.
These industries often require substantial time and resources at various stages of production, resulting in a notable amount of partially completed or unfinished goods around at any given time.
Examples of such businesses include:
- Manufacturing companies
Automotive plants, electronics producers, and aerospace firms - Custom fabrication businesses
Bespoke furniture makers and specialized machine shops
Why tracking WIP inventory is important for your business
Tracking WIP inventory provides valuable insights into your production process:
Reveals production costs and manufacturing efficiencies
Helps identify bottlenecks or quality issues in production
Aids in controlling cash flow tied up in production
Essential for conducting reliable inventory cycle counts
Enables informed decisions about production scheduling and capacity planning
Work in process inventory formula
Calculating WIP inventory is necessary for accurate financial reporting and operational efficiency. The WIP inventory formula helps you determine the value of your partially completed goods at any given point in time.
The formula for calculating WIP inventory is:
WIP inventory formula: Beginning WIP Inventory + Manufacturing Costs – Cost of Goods Manufactured = Ending WIP Inventory
Let’s break this down:
- Beginning WIP inventory
The value of partially completed goods at the start of the accounting period - Manufacturing costs
All costs incurred during production (raw materials, direct labor, and overhead) - Cost of goods manufactured (COGM)
The total cost of goods completed during the period
Here’s a calculator if you don’t want to do the math manually:
Work In Process (WIP) Inventory Calculator
WIP inventory example
Let’s walk through an example to illustrate how you can calculate your WIP inventory.
Imagine your manufacturing company starts the year with a beginning WIP inventory of $20,000, according to your previous year’s accounting records. Throughout the year, your business incurs $80,000 in manufacturing costs.
At the end of the year, you determine the total cost of goods manufactured is $75,000. Here’s how you would calculate your ending WIP inventory:
Beginning WIP Inventory + Manufacturing Costs – COGM = Ending WIP Inventory
$20,000 + $80,000 – $75,000 = $25,000
This means your ending WIP inventory for the year is $25,000.
How do you report work in process inventory on your financial statements?
WIP inventory appears as a current asset on your company’s balance sheet. This classification reflects the expectation that these partially completed goods will be converted into finished products and sold within a year.
The change in WIP inventory levels also affects your COGS on the income statement. An increase in WIP inventory suggests more costs are tied up in production, while a decrease indicates more goods have been completed.
NOTE: Accurate reporting of WIP inventory ensures your financial statements reflect the true cost of your manufacturing process and provide valuable insights into your production efficiency.
4 benefits of effective WIP management
By effectively managing your work in process inventory, you can realize several benefits for your business.
Improved cash flow management
01
Improved cash flow management is one of the primary advantages. Reducing the amount of capital tied up in WIP inventory frees up resources to invest in other areas of your operations or take advantage of new opportunities.
Increased inventory turnover
02
Effective WIP management can also lead to an increased inventory turnover ratio. Minimizing excess WIP inventory and streamlining your production processes allows goods to move through your system more quickly and efficiently.
This can result in faster order fulfillment, improved customer satisfaction, and higher sales volumes.
Identification of production bottlenecks
03
Another benefit of effective WIP management is the ability to identify production bottlenecks or quality issues in your processes. By closely monitoring your WIP levels and analyzing variances, you can uncover areas where improvements are needed.
This enables you to take corrective action and enhance the overall efficiency of your manufacturing operations.
Efficient production scheduling and capacity planning
04
Effective WIP management also facilitates more efficient production scheduling and capacity planning. Having accurate, real-time data on your WIP inventory levels and production rates, aligns your resources with customer demand.
This can help you avoid overproduction or stockouts, reduce lead times, and improve your overall responsiveness to market needs.
4 challenges of excess WIP inventory
Excess work in process inventory can pose several challenges for your business.
Cash flow strain
01
When you have too much capital tied up in your raw material materials and production costs, it can strain your cash flow and limit your ability to invest in other areas of your operations.
Increased storage and carrying costs
02
Holding excess WIP inventory also increases your storage and carrying costs. You may need to allocate more space, labor, and resources to manage and maintain your partially completed goods. This can lead to higher overhead expenses and reduced profitability.
Risk of obsolescence and damage
03
Another risk associated with excess WIP is the potential for obsolescence or damage. As your partially completed goods sit in inventory for extended periods, they may become outdated or susceptible to quality issues.
Wasted materials, increased scrap costs, and potential rework expenses can occur as a result.
Concealed inefficiencies
04
Excess WIP inventory can conceal inefficiencies in your manufacturing processes. When you have a large buffer of partially completed goods, it may be more difficult to identify bottlenecks, quality problems, or other issues impacting your production flow.
WIP inventory costing methods
When valuing your work in process inventory, you have several costing methods available. The method depends on your production process and the nature of your products.
- Weighted average costing
This method calculates the average cost of your WIP inventory by dividing the total cost of goods in process by the total number of units. It is suitable for businesses with homogeneous products and a continuous production process. - First-in, first-out (FIFO)
Under the FIFO method, you assume that the first units added to your WIP are the first ones to be completed and transferred out. This approach is appropriate when your production process follows a sequential order, and the cost of your inputs varies over time. - Last-in, first-out (LIFO)
The LIFO method assumes that the last units added to your WIP are the first ones to be completed and transferred out. While this method is less common, it can be useful in situations where the cost of your inputs is increasing, and you want to match the most recent costs with your revenues. - Standard costing
This method uses predetermined standard costs for your raw materials, labor, and overhead. It is helpful for businesses that have consistent production processes and want to measure variances between actual and standard costs.
PRO TIP: Consider using different costing methods for different product lines if your business has diverse manufacturing processes. This can provide more accurate cost allocation and better decision-making insights.
Job costing vs. process costing
When tracking your work in process inventory, it’s important to understand the difference between job costing and process costing. The choice between these two methods depends on the nature of your products and production processes.
Job costing
Job costing is used when you manufacture distinct, customized products. For example, if you produce custom-built eBikes or specialized landscaping equipment, each job is unique and requires specific materials, labor, and overhead costs.
Job costing allows you to track the costs associated with each individual job and allocate them to your WIP and finished goods inventory accordingly.
Process costing
Process costing is used when you have a continuous production process that produces homogeneous, large-batch products.
For instance, if you manufacture standardized weightlifting equipment or mobility devices in large quantities, process costing is more appropriate. In this case, you allocate your production costs to your WIP and finished goods based on the number of units produced in each process.
PRO TIP: Both job costing and process costing methods help you accurately track your WIP inventory and allocate costs to your finished goods. The choice between the two depends on the specific characteristics of your products and production processes.
How to optimize work in process inventory
Optimizing your work in process inventory is crucial for improving efficiency and reducing costs.
Implement lean manufacturing principles
Adopting lean manufacturing principles, like just-in time production, can significantly reduce your WIP inventory. Focus on eliminating waste, improving flow, and implementing pull-based production systems.
ALERT: While lean manufacturing principles can significantly reduce WIP inventory, implementing them too aggressively can lead to stockouts and production delays. Balance is key.
Techniques like value stream mapping can also help you identify areas where WIP accumulates unnecessarily. Value stream mapping visually charts the entire production process, revealing inefficiencies and areas of WIP accumulation.
Improve production planning and scheduling
Enhance your production planning and scheduling to minimize bottlenecks and reduce idle time. Use advanced scheduling software to optimize your production sequence and balance your production line, reducing the build-up of WIP inventory between processes.
Implement a robust inventory management system
Invest in comprehensive inventory management software that provides real-time visibility into your WIP inventory. This will allow you to track items throughout the production process, identify slow-moving inventory, and make data-driven decisions to optimize your WIP levels.
Regularly review and adjust WIP levels
Conduct periodic assessments to identify variances and investigate the root causes of any discrepancies. Automated systems can help you track and analyze your work in process inventory more efficiently, providing valuable insights into your production process.
Partner with a 3PL
While third-party logistics (3pl) providers specialize in managing finished goods inventory, their systems and expertise can indirectly benefit your WIP management. By providing accurate demand forecasting and efficient finished goods handling, 3PLs can help you optimize production schedules and reduce excess WIP.
3PLs often have advanced inventory management systems and expertise that can help you track and manage your inventory more effectively. They can provide flexible warehousing solutions, real-time inventory visibility, and even handle some light assembly or kitting processes.
This partnership can allow you to focus on core manufacturing while leveraging the 3PL’s logistics expertise to streamline your inventory process.
Transform your business’s operations
Work in process inventory is a key component of your production process and overall inventory management. Accurate tracking and smart management of your WIP inventory can boost your financial health and operational efficiency.
Remember, the goal isn’t to eliminate WIP inventory entirely, but to optimize it. Find the balance that keeps your production flowing smoothly while minimizing tied-up capital. With the right approach, your WIP inventory can become a powerful tool for driving your business forward.
Ready to boost your operational efficiency? Let Red Stag’s expert 3PL services streamline your production flow and maximize your profitability. Contact us today to start a conversation.
