There are many factors that go into a business (i.e. product cost, production rate, employees, etc.). In order for a business that produces and sells a product to be successful, business owners need to be aware of the multitude of elements that lead toward profit. One of the factors that product-based businesses need to be aware of is inventory in relation to production.
There are typically three stages associated with production:
- Raw Materials - all the materials used to create a product
- Direct Materials - Materials that incorporate the final product (i.e the wood used for a bed frame)
- Indirect Materials - Materials that are used in production but are not integral to production (i.e fittings and fasteners or glue used in the bed frame)
- Unfinished Goods - the phase of production where the product is a work-in-progress but is still incomplete. An understanding of how long it takes to create a product can be essential to production
- Finished Goods - products have passed through all phases and are in the final stage and are ready to be consumed or distributed.
There is no stage beyond finished goods, but once finished goods are sold, you can figure out the cost of goods sold (COGS) to re-evaluate production-related costs.
Finished Goods Definition
Finished goods and products are extensions of inventory. They are products that are at the point in the manufacturing process where they are readily available to consumers. Companies calculate finished goods and products through a formula to help create an inventory ratio that determines the value of the goods for sale. Typically finished inventory goods are considered short term assets because they are expected to be sold in less than a year as opposed to long term assets.
Finished Goods Example
Finished goods are based on a number of specific factors. For example, Niche Bakers is a Canadian company that creates baked treats. While their finished goods are the treats that are ready to be sold (i.e. cakes, cookies), the assets that contribute to the finished goods include ingredients, cookware, and any labor needed for production.
How to Calculate Finished Goods Inventory
Businesses of all types calculate the value of finished goods, as well as general inventory valuation. This calculation can help business owners determine the value of their assets in order to prevent material waste, as well as help ensure profitability. It acts as an analysis of the relationship between product input versus product output. This helps make sure that inventory is not being produced at a rate that sales cannot keep up with, and also helps avoid selling inventory when it is not available. The formula itself is very simple:
(Cost of Goods Manufactured - Cost of Goods Sold + Finished Goods Value from the Previous Reporting Period) = Finished Goods Inventory
Sticking with the previous bakery example, if a company makes $1000 worth of baked treats and sells $900, but they have $100 worth of sellable baked treats leftover from the previous day, their finished goods inventory value is $200. The equation works out as such:
($1000 - $900 + $100) = $200
Why Finished Goods Inventory Is Important
Most successful businesses will need an operating budget. An understanding of your finished goods inventory is one of the integral parts of an operating budget. It places a numerical value on each factor that leads to the production of the finished good. Once you have a numerical value on each facet of production, you can better determine the prices at which the product needs to be sold.
When you understand costs, you can then adjust costs accordingly where necessary. For example, if you needed to lower costs, one simple way to do so (in keeping with the bakery example) could be by limiting food waste. If you are a company that is producing a product with an expiration date, and understanding of your finished goods inventory is even more crucial.
Using Finished Goods Inventory in Your Business
While companies can determine their finished goods inventory in their business on their own with the simple equation, it can be a struggle for many to value their finished goods inventory and assets accurately. Even though there are inventory management tips available, managing inventory becomes increasingly complex as companies grow. Many companies utilize automated inventory management software to improve their production rate, their accuracy, as well as their customer service. Automated inventory management software help in areas such as:
- Monitoring part levels - producing purchase/sales orders, pick tickets and any other essential documentation for order management
- Warehouse product location - creating location maps to help find products in a large warehouse
- Shipping - facilitates inventory going in and out while also giving shipping details
- Manufacturing costs - generating costs, but also organizing and reporting that data
Aside from inventory management software facilitating finished goods inventory, businesses can benefit from plugin products. These plugins products that make inventory management even easier are things such as:
When a business understands their factors that facilitate production they can adjust those factors to fit business goals (long and short), but also ensure profitability as a whole.