What is work in process (WIP) inventory? Definition, formula and benefits

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.

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.

These 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.

1. Raw materials inventory: Anything needed to manufacture a product
2. Work in process inventory: All materials waiting to be assembled
3. Finished goods inventory: Assembled materials ready to be sold

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.

Work in process vs finished goods inventory

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.

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:

1. WIP inventory eats up space in a storage space or factory floor that could otherwise be used for inventory that’s ready to sell, thus increasing carrying costs.
2. The more WIP you have on hand, the more capital you have tied up in items waiting to be sold.
3. Too much WIP inventory increases the risk of materials becoming lost, broken, expired, or obsolete before they have a chance to be assembled.

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.

Calculating 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.

Step 1: Gather required information

• Determine your beginning WIP inventory (the WIP inventory from the end of the previous accounting period).
• Collect data on production costs incurred during the current accounting period. This includes labor, materials, and overhead expenses.
• Calculate the cost of finished goods produced during the current accounting period.

Step 2: Understand the formula

• The formula to calculate ending WIP inventory is: 

Ending WIP Inventory = (Beginning WIP Inventory + Production Costs) – Finished Goods Cost

Step 3: Apply the formula

• Insert the gathered values into the formula to calculate your ending WIP inventory.

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

Step 4: Record the WIP inventory

• List the calculated ending WIP inventory value as a current asset on your balance sheet for the accounting period.
• This ending WIP inventory value will also become the beginning WIP inventory for the next accounting period.

Step 5: Keep in mind estimations

• Understand that the WIP inventory value is an estimate and does not account for waste, scrap, spoilage, downtime, or MRO (Maintenance, Repair, and Operations) inventory.
• For precise accuracy, itemize every factor in the production process. However, having an estimate of your WIP inventory is better than having no information at all.

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 on a balance sheet

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:

• A high level could indicate a high level of production activity or a backlog of orders, which could be positive for revenue in the long term.
• This also suggests inefficiencies in the production process, such as bottlenecks or delays, leading to increased holding costs and potential cash flow problems.

Low WIP Levels:

• A low WIP level could signal efficient production processes and lean manufacturing. 

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 WIP inventory

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:

1. Spreadsheets (for smaller operations)

• Create a spreadsheet with columns for item description, quantity, current production stage, associated costs (materials, labor), and estimated completion date.
• Update the spreadsheet regularly as items move through the production process.

Pros: Simple, low-cost, and easy to set up.

Cons: Can become complicated and prone to errors as your business grows.

2. Inventory management software

• Choose software specifically designed for manufacturing or production businesses. Look for features that allow you to track WIP, monitor production stages, and calculate associated costs. Some software options offer additional features like real-time inventory tracking, barcode scanning, and reporting capabilities.

Pros: Offers greater accuracy, automation, and scalability compared to spreadsheets.

Cons: Can be more expensive, and may require a learning curve.

3. Manufacturing Execution Systems (MES)

• This comprehensive software is ideal for larger manufacturing operations. It provides real-time visibility into WIP, including material tracking, labor management, machine utilization, and quality control.

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.

4. Barcode/QR code tracking

• Label each WIP item with a unique barcode or QR code. Then use scanners or mobile devices to track the movement of items through different production stages.

Pros: Simplifies tracking, reduces errors, and provides real-time data.

Cons: Requires an initial investment in hardware and software.

5. Job costing/work orders

• Create individual job sheets or work orders for each product or batch. Track costs (materials, labor, overhead) associated with each job as it progresses.

Pros: Provides detailed cost information for each product or project.

Cons: Can be time-consuming for large-scale production.

Tips for effective WIP tracking:

• Choose the right method: Consider your business size, complexity of production, and budget.
• Update regularly: Ensure that your WIP records are accurate and up-to-date.
• Analyze data: Use the information you gather to identify bottlenecks, inefficiencies, and cost-saving opportunities.
• Integrate with other systems: If you're using multiple software solutions, look for ways to integrate them for seamless data flow.

By implementing effective WIP tracking, you can gain valuable insights into your production process, optimize your operations, and improve your bottom line.

Benefits of well-managed WIP inventory

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: 

Optimize production flow

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.

Reduce costs

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.

Improve resource allocation

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.

Enhance quality control

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.

Create accurate financial reports 

Correct tracking ensures accurate inventory valuation, which in turn leads to more reliable financial reporting and better decision-making.

Enhances forecasting and planning

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.

Increase customer satisfaction

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.

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.