Raw Materials Inventory

Raw Materials Inventory: Definition, Formula, and Turnover

By Team TranZact | Published on Aug 8, 2023

Raw materials inventory is very important for manufacturing-oriented companies. It represents the necessary components for making items. Efficient inventory management ensures smooth operations, meets customer requests and reduces expenses.

TranZact - Best Inventory Management Software

Let's explore how proper tracking, forecasting, and purchasing are important in making sure a well-balanced inventory supports the company's growth and profits.

What Is the Raw Materials Inventory?

Raw material inventory is stock that is yet to be used in manufacturing. Frequently, business owners will get products via a web-based marketplace or wholesale distributor.

Raw material inventory is different for every company depending on a company's finished product. There are two kinds of raw materials inventory:

  • Direct Materials: These are materials that are included in the finished product. For example, wood is used to make a cabinet.
  • Indirect Materials: These resources are not used in the final product but are used during manufacturing. It includes lube, oils, rags, light bulbs, and other items used in a normal manufacturing operation.

Presentation of Raw Materials Inventory

The Raw Materials Inventory is an important part of every manufacturing organization. It represents the necessary components for the production of items. This inventory contains objects in their raw, unprocessed state, ready for a transformation.

The cost of raw materials on hand as of the balance sheet date appears as a current asset on the balance sheet. Inventory costs for finished goods and work-in-progress can all be combined into a single balance sheet line item.

How to Calculate Raw Materials Inventory

You'll need to know the following to find out how to calculate raw materials inventory:

1. Beginning Raw Materials Inventory

To calculate your beginning raw materials inventory, you'll need to be more accurate by using an average raw material inventory formula. The formula for calculating raw material inventory:

Beginning Raw Materials Inventory = (COGS + Ending Raw Materials Inventory) - Raw Materials Inventory Purchased

2. Raw Materials Purchased

Businesses often look to calculate the end of the raw material inventory. Remember that the ending raw materials inventory will become the starting raw materials inventory for the next accounting period.

The following is the formula for the final raw materials inventory:

Ending Raw Materials Inventory = (Raw Materials Inventory Purchased + Beginning Raw Materials Inventory) - COGS

3. Cost of Goods Sold (COGS)

Raw materials inventory turnover is the rate at which raw inventory is used and then replaced. An inventory turnover ratio of 4 to 6 is considered an excellent balance between day sales in raw materials inventory and restocking.

The greater the raw material inventory turnover ratio, the more often raw materials are used and replaced. Raw materials inventory turnover ratios are calculated as follows:

COGS / Average Cost of Raw Materials Inventory

For the average cost of raw materials inventory:

(Beginning Raw Materials Inventory + Ending Raw Materials Inventory) / 2

Raw Materials Inventory Accounting

Keeping accurate records of raw materials purchases allows factories to monitor the progress of their initial investment. It then provides a reliable indicator of the businesses’ financial standing.

1. Accounting for Direct Raw Materials

If direct raw materials are used, a credit should be made to the raw materials inventory asset account, and a debit should be made to the WIP inventory account.

Use a reliable accounting resource to distinguish between identical debits and credits.

2. Accounting for Indirect Raw Materials

Debit the overhead expense account and credit the raw inventory asset account for any indirect raw materials used. The remaining overhead balance is recorded after the accounting period and then transferred to the cost of goods sold.

3. Accounting for Unusable Raw Materials Inventory

Unfortunately, raw materials sometimes become so outdated or damaged that they are no longer usable. Dead stock is a term for inventory that can't be moved.

Anything expired, from raw materials to finished products, falls under the deadstock definition. When this occurs, the expense is often written off against raw materials and added to the cost of goods sold.

Tips on How to Manage Raw Material Inventory

Here are some pointers to help you manage your raw material inventory effectively:

  1. Forecasting and Planning: Examine past data and market patterns to calculate demand correctly. Based on this information, create a thorough plan for procurement and production schedules.

  2. Ready Inventory: Use a just-in-time (JIT) strategy to reduce surplus inventory. It helps avoid carrying costs and the danger of outdated products.

  3. Supplier Connections: Develop solid working connections with dependable suppliers. It helps avoid disruptions, maintain clear communication, and create backup sources.

  4. Safety Stock: Maintain a safety store of critical raw materials to deal with unanticipated increases in demand or supply chain interruptions.

  5. Inventory Tracking Systems: Track and monitor inventory levels in real time with advanced inventory tracking and management software. It assists in identifying trends, improving reordering, and preventing stockouts.

  6. Waste Reduction: Use waste reduction tactics to decrease raw materials inventory throughout manufacturing processes.

  7. Fifo (First-In-First-Out): The FIFO approach ensures that older raw materials are used first, lowering the risk of spoiling or obsolescence.

Managing Your Supply of Raw Materials: Strike a Balance

Raw material inventory management is important for a company's success. Don't fall into the trap of storing extra raw materials because it will provide protection. In reality, storing cash in idle inventory can be harmful.

Conduct regular inventory checks and monitor your fill rate to avoid such problems.

Modern firms rely on raw material inventory management software to balance supply and raw materials. Increasing your sell-through rate and decreasing inventory waste can also aid in raw material management.

A B2B eCommerce platform or a vendor marketplace can help streamline this process. In addition, choose the dropshipping model to avoid handling raw materials or keeping inventory. A well-structured and targeted raw material inventory management procedure ensures your firm runs smoothly and successfully.

Increase Your Raw Materials Inventory Management With TranZact

Accurate raw material handling is important for manufacturing businesses. Proper tracking, forecasting, and purchasing guarantee that operations run smoothly and efficiently. Maintaining inventory levels reduces production delays and ensures client requests are met.

TranZact emphasizes moderation and contemporary inventory management strategies that contribute to profitability through its software.

FAQs on Raw Materials Inventory

1. Could raw material stockpiles be discarded altogether?

Removing raw materials stock completely may be difficult, so, businesses can use drop shipping or just-in-time production strategies to cut inventory levels and run smoothly.

2. Is It Possible That A More Organized Supply Of Raw Materials Might Lead To Happier Clients?

Maintaining an accurate count of raw materials in stock helps avoid product shortages and allows orders to be filled on time. Customers will be more satisfied and loyal if their needs are constantly met on time.

3. What Are Some Common Challenges Associated With the Increase in Raw Materials Inventory Management?

Unreliable demand forecasting, interruptions in supply, shifting market demands, and a need to strike a balance between stock on hand and production are all problems that happen frequently. Data-driven decision-making, cooperation, and careful preparation can help overcome these challenges.

4. How Important Is Technology In Keeping Track Of Raw Materials Supplies?

Technology, such as inventory management software, is important for keeping tabs on, tracking, and controlling stockpiles of raw materials. It helps with demand forecasting, automates ordering operations, and guarantees accurate record-keeping, all in real time.

5. What Hazards Can Result From Having Too Many Raw Materials On Hand?

Stockpiling too many raw materials can be a waste of capital because it forces businesses to pay more to store the materials and can lead to product failure or decay. It can limit the company's cash flow and prevent it from investing in other areas.

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TranZact is a team of IIT & IIM graduates who have developed a GST compliant, cloud-based, inventory management software for SME manufacturers. It digitizes your entire business operations, right from customer inquiry to dispatch. This also streamlines your Inventory, Purchase, Sales & Quotation management processes in a hassle-free user-friendly manner. The software is free to signup and gets implemented within a week.