Understanding work in process (WIP) is key for every growing manufacturing company.
Think of WIP as the story explaining what’s happening between your raw materials at the starting point of your production process, and the finished goods at the end of it.
WIP is the value of whatever’s sitting in the middle. It helps you understand the real financial health of your business, and it uncovers problems and opportunities in your processes.
What is work in process (WIP)?
Work in process basically refers to unfinished products, or goods that are still in the production line.
Think of a lamp. When you start producing it, you have the raw or primary materials, such as plastics and metals. Then, at the end, you have a lamp, and that lamp has a price or value.
But what about that thing between the raw materials and the final product?
Just because your lamp isn’t finished yet, it doesn’t mean it lacks value. Not only did the raw materials necessary cost money, but so did the labor, energy, and factory equipment.
This unfinished lamp is, basically, an item under WIP, which is then listed on your balance sheet.
It includes the cost of the materials, direct labor, and any overhead (like the cost of factory gear) expenses. Some might also refer to WIP as “goods in process.”
As you might guess from the example, WIP is often used by companies with standardized and repetitive production cycles.
They focus on smaller products with higher production quantities, and typically treat WIP as short-term assets with quick completion and selling times.
Why is WIP important?
When your raw inputs enter the manufacturing process, they actually gain value because of the labor and overhead costs (from factory equipment, for example) that goes into them.
WIP is key for tracking that value, and when you do so, you build a WIP inventory.
WIP might seem like overkill for simpler products, but in today’s world, more manufacturers are actually dealing with complex workflows.
A car manufacturer, for example, deals with both raw materials and manufactured goods (called sub-assemblies).
With more manufacturers dealing with these complicated multi-layer production processes, WIP is key in explaining the story between just the raw materials and the final product.
With those insights at hand, manufacturers can use WIP to:
Eliminate production bottlenecks
High WIP levels can be a sign of bottlenecks in your production process, leading to delays and slower output. You can use WIP information to start identifying where those bottlenecks are and, in turn, remove them to produce and deliver faster.
Lower costs and raise margins
Large WIP volumes could eat up resources and drive up storage costs. But as you start cutting bottlenecks in the process, you can start freeing yourself of those added costs. This could help you cut production expenses, reduce waste, and make better use of our resources.
Allocate resources better
WIP inventory information gives you an idea of how your raw materials, labor, and facilities are being used.
You might find that there are bottlenecks because one part of the process wasn’t getting enough attention, while another part was getting too much. With your WIP information, you can shift things around and achieve better overall results.
Improve quality assurance
Keeping an eye on WIP information also helps you catch quality problems. For example, there could be delays in one part of the process due to lower quality work earlier on.
You can use the WIP inventory information to investigate, find, and solve those issues. Not only could this lead to better quality work, but even a higher production output.
Make customers happier
Dealing with high WIP levels could help you produce things faster at a higher quality and, in turn, deliver them to customers earlier.
Provide better financial reporting
Finally, WIP information ties back to your bottom line. It gives you visibility into the total value of your output, not just in terms of raw materials and finished goods, but everything in between too.
This can help with forecasting, seeing if you’re able to meet customer demand, predict problems like excess inventory, and other issues.
How to Calculate WIP
There are three main parts in a WIP formula, which are:
- Beginning WIP inventory value: This is the WIP inventory at the end of your previous accounting cycle.
- Production cost: This is the cost of the labor (including wages, benefits, etc), materials (be it raw or sub-assemblies), and overhead (indirect costs, like the factory equipment, facility costs, maintenance, etc.) during the current accounting cycle.
- Cost of manufactured goods (COGM): This is the cost of the finished or completed goods. COGM is subtracted in the formula because it represents the goods leaving or transferring out of WIP inventory and into the finished goods inventory.
Work in Process formula
The formula to calculate the WIP is the following:
Ending WIP Inventory = (Beginning WIP Inventory Value + Production Cost) – COGM
How to interpret WIP
High WIP Levels
High WIP inventory values could indicate a high level of production activity or a backlog of orders yet to be fulfilled. It can be a positive revenue sign for the long-term.
However, at the same time, WIP also flags potential issues in your production process, such as bottlenecks or delays. If unresolved, these issues could lead to higher holding costs or possible cash flow problems down the line.
Low WIP Levels
Low WIP levels tell you that few items are in an unfinished state at the end of each accounting cycle, which could be a sign of efficient production practices. On the other hand, it could also be a sign of under-used production capacity.
How to track WIP inventory
By this point, you’ll have a good idea of what goes into a WIP calculation, but how do you get the actual information? Well, for that task, you have two main options:
1. Manual techniques
For smaller companies, a spreadsheet with columns specifying details like item information, quantity, material and production costs, production stage, and target completion date is the starting point. It’s simple and low cost to set up.
2. Automated software
As your operations grow in scale and complexity, manually filling and tracking spreadsheets can become error-prone. When you reach this point, you should invest in software that will automate your inventory management and production management tasks.
How to use WIP to improve production and inventory
If you’re finding that you have higher than expected or acceptable WIP inventory levels, then the following tactics could help bring it under control.
Look for potential bottlenecks
Bottles are among the likeliest causes of high WIP inventories. Somewhere along your chain, there is something slowing your production output. These bottlenecks could be (among others) faulty equipment, inefficient processes, or lack of staff training.
Consider industry-standard manufacturing processes
To help solve for bottlenecks, you could look at implementing industry-standard manufacturing processes, like lean manufacturing/just-in-time manufacturing.
Improve production scheduling
Using a manufacturing resource planning (MRP) suite can help you plan and schedule your production tasks in ways that minimize downtime, improve visibility, ensure on-time delivery, better manage resources, and align with order requirements.
Pay attention to other parts of your business
While your inventory is the main reference point for understanding your WIP levels, it’s not the only piece of the puzzle.
For example, a high WIP level due to delays could impact customers who are expecting their orders to be fulfilled by a certain time. You might even be running into production delays due to faster than planned sales cycles.
Next steps: invest in the right software
From the tips above, you can gather that many parts of your wider business (like sales and customer support) can impact WIP. So, as you grow, it’d be a good idea to track these other factors. But to track these other parts, you need different types of manufacturing software.
See our guides for more tips on perfecting your inventory management!