Unfinished Business: How to Manage Your WIP Inventory

BRANDON W. VAHL, CPA, CFE

Work-in-process (WIP) inventory is an important entry on a manufacturer’s balance sheet. Monitoring WIP is critical not only to ensure that your financial statements are accurate, but also because it serves as a useful metric for tracking your company’s performance.

What is WIP?

Simply put, the term “WIP” refers to all inventory in the stage between raw materials and finished-product inventory. Any time direct labor is applied to raw materials that are not yet ready to be sold to customers, their production costs (raw materials, direct labor and factory overhead) are reported in WIP.

The formula for estimating ending WIP in an accounting period is relatively simple:

Beginning WIP + Production Costs – Cost of Goods Manufactured (COGM) = Ending WIP

Suppose, for example, that a manufacturer’s WIP at the beginning of a quarter is $100,000. During the quarter, its production costs total $250,000. The manufacturer’s COGM (the production costs for goods that are available for sale) is $200,000. Its ending WIP, therefore, is $150,000 ($100,000 plus $250,000 minus $200,000).

Related Read: Keep it Simple! “Small” Manufacturers May Opt to Use Simplified Reporting Methods

What are the benefits of tracking WIP?

Estimating and monitoring WIP provides several important benefits, including:

• Reporting More Accurate Inventory Values
  Getting a handle on WIP helps ensure that your inventory is valued accurately on your balance sheet. If you undervalue WIP, you will overstate your COGM, which can distort your financial performance.
• Reducing Reliance on Physical Counts
  Assuming that you have systems in place for tracking and estimating production costs, valuing WIP using the formula discussed above allows you to rely less on costly physical counts of WIP inventory at various stages of the manufacturing process. Physical counts provide important benefits — such as identifying damaged or stolen goods and revealing reporting errors — but properly tracking WIP allows you to reduce your reliance on them.

Related Read: Managing Inventory with Cycle Counting

• Identifying Trends and Red Flags
  WIP is a valuable metric that can reveal significant trends, helping you spot red flags and address them before they damage your profits. For example, excessive WIP can forewarn of bottlenecks in your supply chain or manufacturing process. A large amount of WIP also means higher storage costs and a greater amount of capital tied up in nonsalable assets. And more WIP means more unfinished products, which present a greater risk of damage, loss, expiration or obsolescence while awaiting completion.

Is there an optimal level of WIP?

Generally speaking, in terms of cost and efficiency, the lower your WIP, the better. In some cases, however, a certain level of WIP can be a good thing. For example, having some WIP for employees to work on can minimize downtime when there are delays in the supply chain. And too little WIP can mean excessive completion times for finished products.

The optimal level of WIP varies from manufacturer to manufacturer. What is right for your business depends on several factors, including the number and types of products you manufacture, the nature of your supply chain and operations and your inventory management strategies.

Related Read: How Rolling Forecasts Can Provide More Clarity

Getting help

To manage WIP effectively, you need to be able to measure it. That means you will need to have the ability to track the costs of raw materials, direct labor and factory overhead at various stages of the manufacturing process. Your advisors can help ensure that you have systems in place for collecting the data needed to optimize your WIP.

For more information, contact Brandon Vahl at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.

The High (And Often Hidden) Costs of Employee Turnover

JOEL A. HERMAN, CPA

Most businesses today are facing an unprecedented shortage of skilled labor, so it is more important than ever to retain existing employees. Manufacturers have been hit particularly hard. One reason for this: When the COVID-19 pandemic caused most schools to shift to a remote model, enrollment in many vocational programs — where hands-on learning is essential — declined sharply.

Recognize the full cost

Company management may be reluctant to devote already scarce resources to employee retention, but it is important to consider how much it costs to lose employees. In a recent study, the Society for Human Resource Management estimated that the average replacement cost of a salaried employee is six to nine months’ salary. So losing an employee earning $50,000 per year, for example, will cost approximately $25,000 to $37,500, in addition to the replacement person’s salary. Other estimates are even higher, especially for executives or other highly paid employees.

Some of the costs of employee turnover are apparent, such as those associated with advertising a position, screening and background checks, interviewing applicants, headhunter fees, and training and supervising new hires. In addition, a company may temporarily lose productivity and efficiency while a new employee is learning and training. Additional costs are less obvious, such as the cost of overtime or temporary help needed because of staff shortages, or the negative impact on company culture or morale.

Related Read: Managing the Rising Cost of Labor

Stabilize your workforce

Employee turnover also can affect product quality — a significant hidden cost. A recent study, “The Hidden Cost of Worker Turnover: Attributing Product Reliability to the Turnover of Factory Workers”, found a direct link between worker turnover and product reliability. The authors of the study partnered with a major smartphone manufacturer, tracking failure rates for 50 million phones over a four-year period. They were given access to data that allowed them to trace units that required replacement or repair and cross-referenced this with staffing information for those dates and locations.

The authors found, among other results, that each 1% increase in the weekly turnover rate increased the product failure rate by 0.74% to 0.79%. This finding confirms that products are more reliable when the workforce is more stable.

Related Read: Labor Shortage: How Manufacturers Can Attract and Retain Qualified Workers

Make the investment

Given the shortage of skilled workers and the substantial cost of employee turnover, manufacturers can reap significant benefits by investing in their existing workers. This may include increasing salaries and bonuses, improving benefits, offering flexible schedules, enhancing the culture and camaraderie to keep employees feeling connected or providing training and upskilling opportunities to support employee personal growth. In most cases, the benefits of a stable workforce will outweigh the cost of higher wages, better benefits and improved working conditions.

For more information, contact your ORBA advisor or 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.