Work in Process Inventory (WIP): Definition, Formula, and Examples

Many products are made up of several components that must be created and/or purchased before they can be used to manufacture a final product. For example, think of a computer mouse: it looks like a simple device, but if you take it apart, you would find several different pieces that make the mouse function as it should. 

The cost of purchasing a product factors into what it costs to make it (e.g., raw materials, labor, and production). Thus, your ending WIP inventory is important to know for inventory accounting.

In this article, you’ll learn what costs are associated with work in process (WIP) inventory and how to determine how much WIP inventory you have in production.

What is work in process inventory?

Work in process (WIP) inventory is a term used in production and supply chain management that refers to the total cost of unfinished goods currently in production. WIP inventory is considered an asset on a company’s balance sheet. It’s different from what’s considered ‘finished goods,’ which refers to items ready to be sold as is.  

Businesses that sell highly custom products (e.g., hand-made products on Etsy) are more likely to oversee the WIP inventory process than a business that purchases finished goods directly from a supplier or manufacturer.  

3 terms related to WIP inventory

The cost of WIP inventory is a bit more complex than determining the value of finished goods, as there are a lot more moving parts. Before attempting to calculate your current WIP inventory value, here are some terms and calculations you will need to know first. 

1. Beginning work in process inventory cost

The beginning WIP inventory cost refers to the previous accounting period’s asset section of the balance sheet. To calculate the beginning WIP inventory, determine the ending WIPs inventory from the previous period, and carry it over as the beginning figure for the new financial period.

2. Manufacturing costs

Your manufacturing costs refer to all costs associated with manufacturing a finished product. This includes the cost of raw materials, labor, and overhead costs. The more WIP inventory that goes through the production process, the higher the raw materials and labor costs will be, which will impact the total costs of manufactured goods. The formula is as followed: 

Raw Materials + Direct Labor Costs + Manufacturing Overhead = Manufacturing Costs 

3. Cost of manufactured goods

Cost of manufactured goods (COGM) refers to the total costs incurred to make a final product. You will need to know the final COGM to calculate the value of your current WIP inventory value. COGM is determined by adding the total manufacturing costs with your beginning WIP inventory. From there, you subtract the ending WIP inventory, which will give you the total cost of manufactured goods. The formula is as followed: 

Total Manufacturing Costs + Beginning WIP Inventory – Ending WIP Inventory = COGM

Work in process inventory formula

Once you’re able to determine your beginning WIP inventory, and you calculate your manufacturing costs as well as your cost of manufactured goods, you can easily determine how much WIP inventory you have. The formula is as followed: 

Beginning WIP Inventory + Manufacturing Costs – COGM = Ending WIP Inventory 

Calculating WIP inventory examples

To help you better understand how to determine current WIP inventory in production, here are some examples.

WIP inventory example #1

Let’s say your company’s beginning WIP, as determined by the previous accounting record, is around $10,000 for the new year. During the new year, your business spends $150,000 on manufacturing costs. Furthermore, your total cost of finished goods is $250,000. This leaves your ending WIP inventory as:

Beginning WIP Inventory + Manufacturing Costs – COGM = Ending WIP Inventory

$110,000 + $150,000 – $250,000 = $10,000.

So, your ending work in process inventory is $10,000.

WIP inventory example #2

For a more comprehensive example, let’s say you run a shoe brand with a beginning WIP of $100,000. In the new year, you spend $150,000 on manufacturing costs. Your manufacturer also produced 5,000 pairs of shoes, each costing around $30 to produce on average. Your cost of finished goods is:

$30 x 5000 = $150,000

From there, you would calculate ending WIP inventory amount:

Beginning WIP Inventory + Manufacturing Costs – COGM = Ending WIP Inventory

$100,000 + $150,000 – $150,000 = $100,000

Thus, your ending WIP inventory comes out to be $100,000 for the year.

What is the difference between ‘work in process’ and ‘work in progress?’

The terms ‘work in process’ and ‘work in progress’ are oftentimes used interchangeably, but depending on the industry they could mean something different. ‘Work in process’ typically describes raw materials that are converted into finished goods over a relatively short duration of time. 

On the other hand, ‘work in progress’ is often used in construction and other service businesses and refers to the progress of a project and how much it is costing compared to percentage of completion. When these terms are used by businesses selling a physical product, both mean the same thing. 

How to optimize work in process inventory flow

Most ecommerce businesses rely on a supplier or manufacturer for sellable inventory. The process and flow of WIP inventory is important to understand because it can indicate how efficient your supplier or manufacturer is at producing finished goods. 

By working closely with your supplier and other partners in your supply chain, like a third-party logistics (3PL) company, you can find ways to optimize the supply chain.

1.  Source the right supplier

Unless you sell a highly customizable product, you likely won’t have much visibility into the process of WIP inventory. You do have control over product sourcing and the manufacturer you choose to work with, and it’s up to your manufacturer to keep track of WIP levels and find ways to reduce costs while optimizing their labor, workforce, and production processes. But you can ask your supplier questions like: 

2. Use a 3PL to help with inventory management

Inventory is often the biggest asset of an ecommerce business. Once your WIP inventory turns into sellable goods, you will need a system in place to track inventory as it’s being sold. ShipBob’s technology fully integrates with your store to easily manage all inventory and orders from one central dashboard, while they fulfill your orders on your behalf.  

By partnering with a third-party logistics (3PL) company like ShipBob, you can manage inventory in real-time, view beginning inventory numbers and inventory days on hand, access demand forecasting tools, and get insights into inventory turnover and more. 

“With ShipBob, we have access to live inventory management, knowing exactly how many units we have in Texas vs. Chicago vs. Pennsylvania. It not only helps with our overall process in managing and making sure our inventory levels are balanced but also for tax purposes at the end of the year.”

Matt Dryfhout, Founder & CEO of BAKblade

Conclusion

Understanding WIP inventory can help you better understand supply chain management, so you can find ways to optimize your supply chain to drive more revenue. 

Managing inventory is a major part of growing a successful online store. If you need help with warehousing and fulfillment, be sure to partner with a 3PL that can provide the services, technology, data and analytics, and expertise you need to help you make better business decisions and keep customers happy. 

To learn more about how ShipBob helps ecommerce businesses, contact us by clicking the button below to start the conversation and get pricing.

Work in process inventory FAQ

Understanding WIP inventory can be challenging, especially since it consists of many moving parts during the production process. Here are some common questions that companies have on WIP inventory.

How do you calculate work in process inventory?

To calculate the WIP precisely, you would have to manually count each inventory item and determine the valuation accordingly. Fortunately, you can use the work in process formula to determine an accurate estimate. It is: Beginning WIP Inventory + Manufacturing Costs – COGM = Ending WIP Inventory.

 

What does work in process inventory mean?

Work in process (WIP) inventory refers to the total cost of unfinished goods currently in the production process at the end of each accounting period. It is also considered a current asset on a company’s balance sheet.

 

Why is work in process inventory important?

Knowing how to accurately calculate WIP inventory can impact your balance sheet. If your business offers highly customized products, then it’s important to understand how WIP inventory works, what goes into the cost, and how to calculate it at the end of the accounting period. This will give you a sense of COGS based on how much it costs to produce and manufacture finished goods.