There are 3 types of inventory that most manufacturers and merchants are likely to encounter. These are Raw Materials, Work in process and Finished Goods. Raw materials are the basic materials that a manufacturer purchases from suppliers in order to build finished products.
Raw materials inventory refers to the total cost of all the components used to manufacture a product. These materials can be classified as either direct materials (DM) or indirect materials (IM).
Direct materials are components that can be easily linked back to a finished good. For example, if your finished product is a wooden clock, then a direct material would be the wood that goes into making the clock; this raw material is easy to trace back to its original state and the quantity used in each product is likely to be almost identical. However the glue that is used to make the clock is less easily quantifiable and measured, therefore, it is an indirect material.
Raw materials need not be in their unaltered state. For example if the finished good being manufactured is a blender, then raw materials for the blender could include stainless steel to make the blades and the engine, purchased as a complete part from a supplier.
How do you calculate raw materials inventory?
To understand what a raw materials inventory looks like and how it is calculated, let’s circle back to the example of a wooden clock.
Let’s say the production manager orders $24,000 worth of raw materials in total.
In order to make one production cycle of wooden clocks, the manager moves $4,400 in wood, $500 in clock faces, $500 in mechanisms, $300 in glue and $300 in wood varnish into production.
The wood, clock faces and mechanisms will fall under direct materials. The total cost of the direct materials is $5,400.
The glue and wood varnish are indirect materials and by common practice, will be classified as manufacturing overheads. The total cost of the manufacturing overheads is $600.
To calculate the raw materials inventory, add the cost of the direct materials in production with the manufacturing overhead. In this case your raw materials inventory is valued at $6,000.
Raw materials inventory—
This method of calculation seems simple enough but extrapolated by hundreds of products, all with their own raw materials and the inventory calculations pile up fast!
If you manage your own manufacturing lines, raw materials inventory is an important part of your business. You need to understand how much ROI you are getting for your raw materials with each round of purchasing and removing production lines with high manufacturing overheads but low profit margins.
With multiple products, all with different production cycles, keeping track of your raw materials can be a nightmare for small and growing businesses. Use dedicated tools like TradeGecko to track your production cycles and create a bill of materials, so you can stay ahead of the game with raw materials inventory.
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