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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.

What is work in process inventory?

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.

Work in process vs. work in progress inventory

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.

Work in process inventory in the big picture

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.

Why is it important to classify work in progress inventory?

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.

How to calculate work in process inventory

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.

Work in process inventory formula

The total WIP inventory value is the ending work in process inventory for an accounting period—and the beginning work in process inventory for the next accounting period. This ending inventory figure is listed as a current asset on a balance sheet.

To calculate WIP inventory, you need the beginning work in process inventory, and to calculate that, you need the ending work in process inventory.

Here’s how it looks:

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

Work in process inventory formula in action

Let’s say you start the year with $10,000 worth of raw materials. You incur $300,000 in manufacturing costs and produce finished goods at a cost of $250,000. Your WIP inventory formula would look like this:

($10,000 + $300,000) – $250,000 = $60,000

Work in process inventory = $60,000

The WIP figure indicates your company has $60,000 worth of inventory that’s neither raw material nor finished goods—that’s your work in process inventory.

Keep in mind this value is only an estimate. It doesn’t take into account waste, scrap, spoilage, downtime, and MRO inventory. In order to achieve 100% accuracy, you’d need to itemize every factor in the production process. That said, it’s better to have some grip on your WIP inventory than none at all.

How to optimize your inventory management with WIP inventory

Out of the three main types of inventory, WIP inventory is usually the most overlooked. But as you’re about to see, keeping tabs on this metric has big benefits.

1. Get a more accurate value of your business

Since WIP inventory is an inventory asset, neglecting to include it on your business’ balance sheet can cause your total inventory to be undervalued. As a result, the cost of your finished goods will be overstated. For tax purposes, it’s best to track WIP inventory to get an accurate breakdown of what your inventory is actually worth.

2. Spot red flags sooner

Growing WIP inventory figures are a red flag for managers. A high WIP inventory number can indicate that your production process isn’t flowing smoothly and that there may be bottlenecks in the process. By tracking WIP, you can pinpoint and eliminate these problems before they hurt your bottom line.

3. Avoid hand-counting inventory

Some companies do a physical count of their WIP inventory to determine the value based on the current stage of each unit in the manufacturing process. This eats up huge amounts of valuable time and distracts your team from doing higher-level work.

Using the WIP formula will give you a good idea of the value of your inventory without the headache of hand-counting.

Final thoughts

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.

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