The term “raw materials inventory” describes a company’s stock of materials that have not yet been put to use in the production of a finished good. Raw materials are used in this production process to create work-in-progress inventory, which transforms into finished goods the company will sell.
Raw Materials Inventory
How to calculate raw materials inventory
The raw materials inventory is calculated from three values:
Inventory of raw materials equals initial inventory plus raw materials purchased minus cost of goods sold.
Here are steps to help you calculate raw materials inventory:
1. Determine the time period
When calculating raw material inventory, it’s crucial to choose the time frame for which you’ll be collecting the data. For instance, the formula values used in a company’s calculation of raw materials inventory for its reporting periods every three months would be based on the previous three months of operations.
2. Discover the value of the starting raw materials inventory
By gathering all the direct and indirect materials from the beginning of a given period and adding up their costs to determine their total value, you can determine the value of a company’s initial raw materials inventory. Essentially, this is the final raw materials inventory from the prior accounting period.
3. Calculate the raw materials purchased
Keep track of any raw materials you buy over the specified period, and then calculate the total of those purchases. By doing so, you’ll be able to estimate the value of the raw materials you bought. Add that amount to the starting raw materials inventory value after that.
4. Subtract the cost of goods sold
The final step is to calculate your raw materials inventory by taking the total costs of all finished goods and products sold during the specified period and subtracting those costs from the total of initial raw materials and raw materials purchased.
For instance, a furniture manufacturing company would first determine the value of its inventory at the start of its four-month period, which was $40,000, before attempting to calculate its raw materials inventory for the previous four months. The total cost of raw materials purchased over the previous four months, which came to $35,000, would then be calculated. It would then calculate the cost of goods sold, which came to $25,000 over a four-month period. Their raw materials inventory would then be:
What is raw materials inventory?
The estimated value of a company’s basic components used to create and produce its products is known as raw materials inventory. These are goods that are currently in stock and available for use, and are referred to as “pre-production inventory.” Due to their contribution to a manufacturer’s overall product inventory, companies and organizations frequently list raw materials as a current asset when creating financial documents, such as a balance sheet.
There are two subcategories of raw materials:
How to calculate raw materials inventory turnover
Cost of goods sold divided by the average raw material inventory is the raw material inventory turnover.
The calculated rate that demonstrates when businesses use the raw materials they have on hand and need to replace them is known as the raw materials inventory turnover. This calculation can assist in forecasting future inventory requirements and the need for additional raw material orders for a business.
The following steps will assist you in determining the raw materials inventory turnover:
1. Determine the calculating period
To determine turnover, a business must use formula values from a predetermined period, just like when calculating raw materials inventory. The period most companies use is often one fiscal year.
2. Calculate the average raw materials inventory
The simplest method for determining average raw material inventory is to add the beginning and ending inventory values, then divide the result by two. For instance, the average would be ($20,000 + $25,000)/2, which equals $22,500, if a company’s starting raw materials inventory value at the start of its fiscal year was $20,000 and its ending inventory value was $25,000.
3. Find the cost of goods sold
Lastly, calculate the total cost of goods sold for the fiscal year and then divide that amount by the average raw material inventory. The total is the raw materials inventory turnover.
Example of raw material inventory turnover
To determine its raw materials turnover rate for the most recent fiscal year, a furniture manufacturing company would first determine its average raw materials inventory. It would add the $53,000 value of its ending inventory to the $60,000 value of its starting inventory from the beginning of the year.
That number would be divided by two, equaling $56,500. The business would then divide its annual cost of goods sold, which was $229,000, by the typical raw material inventory, which was $56,500. That would equal 4. 05, the companys raw material inventory turnover.
The company could divide the 365 days in a year by its inventory turnover rate of 4 if it wanted to learn more about the turnover of its inventory. 05. This could assist in calculating the firm’s precise inventory turnover rate to determine how frequently it must replenish its inventory each year. In this case, the equation 365/4. 05 would equal 90. 12. This indicates that the business, on average, replaces its current inventory of raw materials with new inventory every 90 days.
Tips to manage raw materials inventory
Here are some pointers you can use to better manage your inventory of raw materials:
Automate data collection and management
Automation of inventory management systems can be very beneficial in the manufacturing and production industries. Computer software or other technology can assist businesses in a number of ways, including data collection and sorting, inventory forecasting, cost estimation, and more. This knowledge offers helpful insights into producing business products in the most economical manner while avoiding overstocking or understocking their raw materials.
Understand overstock and understock
Having too much or too little of a particular raw material or product in your inventory is referred to as overstock and understock. There are a number of ways to find solutions if a business encounters problems with inventory and stock management, including:
Use quality raw materials
Utilizing high-quality raw materials can help businesses cut costs and time while potentially raising customer satisfaction. When businesses and organizations attempt to use inferior raw materials, they run the risk of encountering difficulties or problems that could slow production, including inconsistent and defective final manufactured products. Although more expensive, higher-quality raw materials can help reduce other costs over time and produce goods that customers will value more.
What are the example of raw materials inventory?
- #1 Decrease supply chain lead times. …
- #2 Reduce production lead times. …
- #3 Automate the ordering process. …
- #4 Improve relations with your suppliers. …
- #5 Purge or re-purpose obsolete stock. …
- #6 Reduce order sizes. …
- #7 Forecast more accurately. …
- #8 Switch to versatile components.
What is difference between inventory and raw materials?
The inventory or input goods that a business needs to manufacture its products are known as raw materials. Steel, oil, corn, grain, gasoline, lumber, forestry resources, plastic, natural gas, coal, and minerals are a few examples of raw materials.
Why is raw material inventory important?
Inventory of raw materials Inventory of raw materials includes components needed to produce finished goods. Commodities or components that businesses purchase or extract themselves can be considered raw materials. In essence, they are all stock that has not yet been put to use in manufacturing.
What are the 3 types of inventory?
To ensure that the production process runs smoothly with good quality, on schedule, and at an affordable price, the companies must be able to maintain an inventory of raw materials. Too many inventories will hurt businesses because they have to spend a lot of money on the inventorying process and invest capital.