Work in Process (WIP) Inventory
What does it mean
Work in Process (WIP) is a subcategory of inventory which typically contains the total value of raw materials that are currently somewhere in the manufacturing process. For example in a coffee roasting business, this value would include coffee that is roasted and or ground, but not packaged.
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 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 Work in Process levels could indicate the following:
- Work in Process Increases
- Supply chain issues - maybe they are missing a single component to fully complete the work. Until that component arrives, that inventory will sit in the Work in Process bucket
- Revenue increasing - All things equal, higher revenue will result in higher Work in Process
- Work in Process Decreases
- Becoming more efficient
- Revenue decreasing
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
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