What is Work in Progress (WIP)?
Work in Progress (WIP) represents incomplete goods still in the production process, i.e. the manufacturing stage between raw materials and finished goods.
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How to Calculate Work in Progress (WIP)
Work in progress (WIP) is a term used to describe inventory that is partially finished and currently amidst the production cycle.
WIP stands for “work in progress” and refers to any partially complete inventory not yet ready to be sold to customers.
At the WIP stage, these inventory items are not marketable and require more time before it can be sold in the market.
For instance, the WIP inventory could be undergoing finishing touches prior to being marked as complete.
- Raw Materials → The materials on hand that are part of the production process, e.g. commodities.
- Work In Progress (WIP) → The process of turning the raw materials into finished goods has begun, however, the item is not yet ready to be sold.
- Finished Goods → The production process is complete and these items are now ready to be sold.
Once the product is marked as a finished good and is subsequently sold, the appropriate amount is removed inventory balance on the balance sheet.
On the income statement, the sale of the product would be recorded in the cost of goods sold (COGS) line item.
Work in Progress Formula (WIP)
The formula for calculating work in progress inventory – in the specific context of a manufacturer – is as follows.
- Ending Work in Progress (WIP) = Beginning WIP + Manufacturing Costs – Cost of Goods Manufactured
The beginning work in progress (WIP) inventory is the ending WIP balance from the prior accounting period, i.e. the closing carrying balance is carried forward as the beginning balance for the next period.
The manufacturing costs are then added to the beginning WIP inventory balance.
Manufacturing costs are a bit of an open-ended term but refer to any costs incurred related to the process of manufacturing raw materials into a finished product, e.g. the cost of raw materials, labor, and overhead costs.
Manufacturing Costs Formula
- Manufacturing Costs = Raw Materials + Direct Labor Costs + Manufacturing Overhead
In the final step, the cost of manufactured goods (COGM) is subtracted.
COGM is defined as the total costs incurred while creating a finished product, and in order to estimate the value of a company’s end-of-period WIP, the finished COGM is a necessary input.
COGM can be determined by adding the total manufacturing costs to the beginning WIP inventory, followed by subtracting the ending WIP inventory.
Cost of Manufactured Goods (COGM) Formula
- Cost of Manufactured Goods (COGM) = Manufacturing Costs + Beginning WIP Inventory – Ending WIP Inventory
How to Interpret Work In Progress Inventory
Work in progress (WIP) inventory can be found on the current assets section of the balance sheet, which reflects how inventory is expected to cycle out within a twelve-month period, i.e. be converted from raw materials into cash.
Generally, most companies strive to reduce the amount of time that inventory spends at the work in progress (WIP) stage.
- Long WIP Stage → The longer the items remain in the WIP stage, the less efficient that company may be – all else being equal.
- Quick WIP Stage → The quicker the inventory cycles out (i.e. as part of the cash conversion cycle), the more free cash flow (FCF) there tends to be since the cash is not merely sitting as inventory.
However, different industries will have different targets for their WIP and inventory management KPIs, particularly for more technical, manufacturing-intensive products that require substantially more time to pass through the WIP stage.
Therefore, it is also essential to make internal comparisons (i.e. track the changes in WIP year-over-year), as well as avoid making comparisons between companies operating in entirely different industries, i.e. stick to the company’s closest competitors and other industry peers to determine the proper target WIP benchmark.
Work In Progress Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
WIP Inventory Example Calculation
Suppose a manufacturer is attempting to calculate its work in progress (WIP) for the end of the latest fiscal year, 2021.
If the beginning WIP balance is $20 million, the manufacturing costs were $250 million, and the cost of goods manufactured (COGM) is $245 million, what is the ending work in progress (WIP) balance?
The assumptions that our model will use are as follows.
- Beginning Work in Progress (WIP) = $20 million
- Manufacturing Costs = $250 million
- Cost of Goods Manufactured (COGM) = $245 million
The ending WIP roll-forward starts with the beginning WIP balance, adds the manufacturing costs, and then deducts the cost of goods manufactured (COGM).
If we enter those inputs into our WIP formula, we arrive at $25 million as the ending work in progress (WIP), reflecting an increase of $5 million in WIP from the beginning to the end of the period.
- Ending Work in Progress (WIP) = $20 million + $250 million – $245 million = $25 million