Inventory Flow in Manufacturing
Manufacturing companies have three classes of inventory. Costs flow through them sequentially:
Raw Materials Inventory
↓ (materials requisitioned)
Work in Process Inventory ← Direct Labor added
↓ ← Manufacturing Overhead added
↓ (units completed)
Finished Goods Inventory
↓ (units sold)
Cost of Goods Sold (Income Statement)
The Three Inventory Categories
| Category | What It Contains | Balance Sheet Example |
|---|---|---|
| Raw Materials | Materials purchased, not yet used | Electronic components waiting for assembly |
| Work in Process (WIP) | Partially completed units | Navigation systems mid-assembly |
| Finished Goods | Completed units, not yet sold | Completed navigation systems in warehouse |
These are parent categories for financial reporting. Companies subdivide within them (by SKU, location, batch) for operational tracking.
Accounting Entries Mirror Physical Flow
| Event | Debit | Credit |
|---|---|---|
| Purchase materials | Raw Materials Inventory | Cash/AP |
| Use materials in production | Work in Process | Raw Materials |
| Incur labor/overhead | Work in Process | Wages Payable/Various |
| Complete units | Finished Goods | Work in Process |
| Sell units | Cost of Goods Sold | Finished Goods |
Merchandising vs Manufacturing
| Company Type | Inventory Categories |
|---|---|
| Merchandising (retailer) | Merchandise Inventory only |
| Manufacturing | Raw Materials, WIP, Finished Goods |
| Service | Typically none (or unbilled hours as WIP) |
Merchandisers don't transform anything—they buy finished and sell finished.
North: Where this comes from
- Product vs Period Costs (product costs flow through inventory)
- Matching Principle (costs become expenses when revenue is recognized)
East: What opposes this?
- Period Costs Flow (bypass inventory, expense immediately)
- Service Company Operations (no physical inventory)
South: Where this leads
- Universal Inventory Formula (calculating flows at each stage)
- Cost of Goods Manufactured (what exits WIP)
- Cost of Goods Sold (what exits Finished Goods)
West: What's similar?
- Supply Chain Stages (procurement → production → distribution)
- Value Stream Mapping (visualizing flow of materials and information)