Understanding Work in Process Inventory: Formulas, Applications, and More

Today’s business environment is increasingly more competitive. Companies must find ways to cut costs and control processes. An area that is frequently forgotten is the Work in Process (WIP) inventory. This asset plays an essential role in decoupling workstations and smoothing production. Still, it is often of significant value, tying up capital that could be used more effectively elsewhere.

In this article, we’ll show how to calculate and control WIP inventory, examine WIP inventory applications, and explain the benefits of WIP control.

What is work in process (WIP) inventory?

Work In Process is used to describe inventories in various stages of production. The term covers all partially completed subassemblies and components. WIP value includes all materials, labor, and overhead invested in raw material conversion.

Work in process forms a crucial part of the production process. It ensures smooth production by ensuring that the material available at each workstation is ready for the next step in the process. Without WIP, production might have to wait for materials from the previous stage.

WIP buffers production schedule changes and reduces lead times. Companies that effectively manage WIP can, thus, quickly respond to demand changes.

How WIP impacts inventory

WIP increases the inventory value. The WIP value includes the resources used to transform materials, so it can have a significant value. Planners must track and manage WIP to ensure the business has the right components in the right quantities to support production.

Excess WIP ties up cash. It requires storage space and can become damaged or obsolete. The financial implications may be significant. Effective inventory management, thus, is crucial in the management of WIP.

WIP formula and how to calculate

Where:

• Ending WIP Inventory: The value of partially completed items at the end of a specified period (usually a month or year)
• Beginning WIP Inventory: The value of the partially completed items at the end of the last period.
• Manufacturing Costs: The cost, in the previous period, of transforming raw materials into semi-completed items. These costs include:
  • Direct materials
  • Direct labor
  • Manufacturing overhead: These are the indirect costs of manufacturing goods. Manufacturing overheads include factory rent, utilities, and depreciation.
• Cost of Goods Manufactured: The cost of finished goods transferred out of production during the previous period.

Step-by-step guide on calculating WIP inventory:

• Identify beginning WIP inventory: This figure appears on the previous period’s balance sheet under WIP inventory.

• Calculate total manufacturing costs: Add the direct material, direct labor, and direct overhead for the period

• Determine the cost of goods manufactured: This figure usually appears on the income statement. If it does not you will have to add these costs together.

This is demonstrated in the example below:

Why accurate WIP inventory is important?

1. Accurate accounting: WIP forms part of the inventory on the balance sheet. An incorrect WIP value will misrepresent the company’s financial position.
2. Informed decision-making: Managers need accurate WIP figures to plan production, manage inventory, and allocate resources.

Work in process vs work in progress

Work in Process and Work in Progress are often used interchangeably. There are subtle differences between them.

Work in Process is used in production environments to describe partially completed goods. The value covers the direct materials, labor, and overhead invested in the incomplete processed items.

Work in Progress is a broader term. It covers all incomplete work including projects, tasks, and services. The term is usually used in the service industry. Both Work in Process and Work in Progress refer to partially completed work. Both affect resource allocation.

Manufacturing businesses must manage WIP to ensure the smooth flow of goods between processes. They must balance process flow with inventory holding. In recent years concepts like Just-in-Time have come into common use aiming to reduce the value of WIP.

In service industries, WIP management revolves around resource allocation. Service businesses use WIP to overcome resource availability problems. Personnel use project management tools to keep projects on track.

Importance of managing WIP inventory

WIP inventory management is crucial for efficient business operations. Benefits of managing WIP inventory include:

• Improved cash flow: Excess WIP stocks lock capital into inventory. Streamlined, well-managed WIP reduces inventory value and improves cash flow.
• Enhanced production efficiency: WIP progress tracking enables more accurate machine and labor loading forecasts. Use this data to replan schedules or add production resources.
• Improved customer service: Reduced production lead times and efficient workflows lead to quicker order fulfillment and more satisfied customers.

Expect to encounter challenges in your bid to manage WIP inventories:

• Balancing WIP: You will have production difficulties if you don’t have enough WIP. Too little inventory will disrupt workflows. Still, excess inventories need storage space, increase costs, and tie up cash. You must find the perfect balance to optimize your WIP inventories.
• Demand changes: Unexpected demand fluctuations can disrupt production plans when there is less WIP.
• Material shortages: Supply chain disruptions may disrupt workflows when there is less WIP.

The need to reduce inventories has led to production strategies that aim to reduce the value of WIP. These include:

• Lean manufacturing: This system aims to remove all waste from the system. Techniques include quicker machine setups, reduced defects, and improved workflows.
• Just-in-Time inventory: Materials arrive as they’re needed for production. Just-in-time systems depend heavily on reliable supply lines.
• Software solutions: Automated processes and real-time WIP inventory tracking enable more accurate forecasts and better load balancing at workstations.

Applications of WIP inventory in business

WIP inventory is an essential part of efficient business management. Its importance starts with demand forecasting. It ends only when the product leaves the factory and enters the sales and marketing arena.

• Production scheduling: WIP data enables more efficient production planning. The planner knows what is partially complete and can use this data to plan work center loads.
• Bottleneck identification: Organizations use WIP to identify bottlenecks. WIP accumulates behind the bottleneck, making the problem obvious. Bottleneck management can significantly improve process lead times and operational efficiency.
• Inventory reduction: Knowing the inventories in the process helps to drive down stocks.
• Improved visibility: Real-time data enables better decision-making. This is particularly useful when planning unscheduled production changes.

Integrating WIP into your inventory management software brings many benefits. Advantages include automated real-time WIP tracking and improved interdepartmental communication. Everyone has access to WIP data.

Successful companies worldwide have created a competitive edge by excelling in WIP management.

Two companies, Toyota and Dell Technologies, are well known for their WIP management techniques. Toyota developed Toyota Production Systems, which have been shared and admired globally. These systems incorporate lean manufacturing and pull production using kanbans. The company has achieved significant WIP reductions along the way.

Dell adopted JIT and was equally successful in lowering WIP. This efficiency enabled the company to quickly introduce modern technologies.

How inventory management software can help

Inventory management software offers companies many WIP features and benefits. Features include:

• Real-time monitoring: WIP levels are always visible across all workstations. This allows management to identify bottlenecks and potential delays.
• Automated calculations and reporting: The software generates reports. It automatically calculates lead times and order quantities.
• Integration with other business systems: Integrate your WIP inventory with other business systems, such as Enterprise Resource Management and Materials Requirements Planning. This ensures easy data migration and the same information across systems.

WIP inventory management software has a few benefits.

• Increased accuracy: Automated calculations and real-time WIP tracking minimize the chance of errors
• Time savings: Employees can get on with other more important tasks because they have less manual work.
• Better decision-making capabilities: Data-driven insights enable better production planning, resource allocation, and inventory optimization decision.

Once you have decided to install WIP software, there are several aspects to consider, including:

• Scalability: Choose a system that will grow with your business. The software must manage a higher level of WIP complexity
• Customizability: Look for software you can tailor to your needs.
• User-friendliness: The software must be easy to use. This facilitates training and promotes user adoption.

Every modern business needs effective management software to compete. Experience the benefits of software-supported WIP inventory management. Reduce your costs and your operational effectiveness.

Smoother production, reduced costs, better cash flow

Optimizing WIP inventory is essential for smoother production, reduced costs, and better cash flow. Inventory management software helps achieve operational excellence through real-time WIP tracking, enabling more effective machine planning and reducing lead times.