Raw Materials Inventory

What does it mean

Raw Materials is a subcategory of inventory which typically contains the components that will be used to create the finished product, but at this point have not been used in operations.  An example of this for a coffee roasting business would be the unroasted beans.  

Why does it matter

Knowing the breakdown of the inventory between Raw Materials, Work in Process and Finished Goods is important for two main reasons.

The first is that inventory is likely a major component of the collateral for any operating debt that is provided.  Why this matters is because certain types of collateral are better than others.  In the case of inventory, the Raw Materials and Finished Goods provide more collateral value than does the Work in Process, and the reason is pretty easy to understand.  It is a lot easier to find someone to purchase either the inputs of a product (bags & unfrosted coffee beans) or the finished product (shelf ready bags of roasted coffee), but it is more difficult to find someone to purchase partially completed orders that are in the manufacturing process.  Due to this, the advance rates for these items differ with a lower advance rate typically being given to Work in Process.

The second reason is that understanding the breakdown of inventory between the three types helps to see how the business is operating. 

Changes in Raw Material levels could indicate the following:

• Raw Material Increases
•  Slow down in production
•  Customer buying extra due to a good deal
•  Supply chain worries prompt them to hold more just in case
• Raw Material Decreases
•  Ramp up in production
•  Supply chain issues

Changes in balance sheet values typically can have both positive or negative reasons for why they occur.  Identifying these changes and having a conversation with the customer helps to know which one it is.

Other Relevant Terms

• Capital
• Current Assets
• Current Liabilities
• Inventory
• Work in Process
• Finished Goods
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