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What Is Finished Goods

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226 views5 pages

What Is Finished Goods

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Uploaded by

xin nian
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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What Are Finished Goods?

Finished goods are products that have passed through all the stages of
manufacturing and are ready for sale. Think of finished goods as what you
see on the shelves in stores — i.e., the “merchandise” — though finished
goods may also be found in warehouses and distribution centers.

Key Takeaways
 Knowing the amount and value of finished goods inventory helps a
company understand its profit and determine future budgeting needs.
 Proper management of finished goods inventory helps a business
satisfy demand for its products and reduce the likelihood of missed
sales (stockouts) and lost revenue.
 A good grasp on finished goods inventory can help a company
reduce wasteful spending on raw materials and storage space.
 Finished goods inventory is included in the current asset section of a
company’s balance sheet.
 Tracking finished goods inventory by item or stock keeping unit
(SKU) is important and labor-intensive.

Finished Goods Inventory Defined


Finished goods inventory is the third and final classification of inventory that
is used for accounting purposes by manufacturing companies, the items
that are sold to the customer. Manufactured products begin as raw
materials and then move into the work-in-progress (WIP) stage as they are
being produced. End products ready for distribution and sales constitute
the finished goods inventory.

Accounting for inventory follows that production workflow. Inventory value


moves from raw materials to WIP and, ultimately, to finished goods through
entries in the business’s different general ledger accounts. The process of
moving inventory values from one account to the next allows the
manufacturer to see how much inventory it has at any of the three stages.
Some businesses, such as retailers that buy completed products from
wholesalers to sell directly to consumers, might skip the first two
classifications and only carry finished goods inventory.

It’s important to note that, as an element of business accounting, finished


goods inventory is expressed in terms of the dollar value of the inventory,
not the number of items. Finished goods are considered a short-term asset
because they are expected to sell within 12 months; finished goods
therefore appears as a current asset on a company’s balance sheet.

Why Is Finished Goods Inventory


Important?
Well-managed finished goods inventory is important to the success of a
manufacturing company or a retail store. By tracking it, a company better
understands the inventory it has in stock for sale, helping to gauge how
large an order it could accept at a specific point in time. For example, if a
parent called an electronics store to see if it has the gaming console their
child wants for their birthday, an effective finished goods inventory system
could easily answer that question, as well as identify other stores that may
have it and how many are still in stock.

Studying the history of this inventory also can help a business plan by
revealing trends in seasonality or other sales fluctuations, leading to a
deeper understanding of the goods that sell quickly and the ones that do
not; this, in turn, feeds into analyses of the company’s cash flow and how
much cash has been allocated to inventory. Inventory turnover is an
important inventory management key performance indicator (KPI) that tells
a company how many days it would take to sell out its current finished
goods inventory and, therefore, whether it has too much or not enough
cash tied up in inventory. The longer items remain in finished goods
inventory, the less profitable the company is likely to be because of added
storage fees, damage, obsolescence or the unrecovered expenses of
making the finished goods.
3 Steps to Becoming Finished Goods
For a manufacturing product to be considered finished goods, it must go
through three accounting stages that reflect its production process. To
illustrate those steps, consider the hypothetical rowboat manufacturing firm,
Oar Master Inc. (OMI).

1. Raw materials: These are the objects needed to create the product.
For OMI, that means wood, oarlocks and carbon-fiber plastic to make
the shell of the boat, to name a few. For each product, it’s important
for OMI to keep the correct level of stock of raw materials inventory
on hand to feed the production process and generate the right
quantity of finished goods.
2. Work in progress: Items in the various stages of production are
considered WIP inventory. They’re not yet ready for distribution or
retail. The outer shell of a rowboat without the seating inside it or the
oarlocks in place is, obviously, a WIP. WIP inventory value includes
materials, labor and direct overhead costs.
3. Finished goods: The fully manufactured and painted rowboat,
outfitted with seating and oarlocks, represents the finished goods in
this example. That boat is now ready to be shipped to its distribution
destination.

Finished Goods Examples


Everything people buy is a finished good, including the device on which
you’re reading this article. The items you bought the last time you went
food shopping are finished goods. The car you drove to get to the
supermarket is a finished good. The wallet that held your cash and credit
cards is a finished good.

Depending on the type of company, it also is feasible for the finished goods
of one business to be the raw materials of another. For example, a
manufacturing company may make nuts and bolts, nails, screws and
washers, which are all finished goods that become the raw materials for a
different company that needs them to make its finished goods — a child’s
backyard swing set, a backup power generator, a rowboat.
Finished Goods Terminology
When it comes to understanding finished goods inventory and how to
determine its value, it’s important to be familiar with the key components
that go into its calculation.

 COGS — Cost of Goods Sold: COGS represents all of the direct


costs a company incurred to create the finished goods it sold in a
given period — such as a month, a quarter or a year. It includes the
costs of materials and labor but excludes indirect expenses, such as
distribution and sales costs. For example, if you run a printing
business, COGS would include the paper, ink, binding materials and
labor needed to produce printed materials, but not the shipping costs
to deliver the finished goods to the destination point. COGS
calculations reflect several different expense accounts and are
shown as a subtotal on an income statement. Because COGS shows
a business the true cost of the products it sells, it is crucial input for
setting customer prices that ensure an adequate profit margin.
 COGM — Cost of Goods Manufactured: COGM is similar to
COGS, but it calculates the cost of all the finished goods a company
produced during a specific time period, regardless of how much has
actually been sold. It includes the direct costs of the materials
required to make the finished goods, the labor involved and the
manufacturing overhead. Also included is the value of WIP inventory
at both the beginning and the end of the period in question.

COGS and COGM are similar concepts, with the primary difference
being the specific items included. COGS is the direct costs of the
items that were sold during a given fiscal period. COGM is the costs
of the items being manufactured, which may be different than those
being sold. An extreme example is that a car company may incur
COGS related to pickup trucks sold out of inventory during a month in
which its factory was closed and, therefore, the company had zero
COGM.

 WIP — Work in Progress: This is the inventory of items being


processed but not yet ready for distribution or sale. You may also see
it referred to as work in process, and the terms typically are used
interchangeably. WIP is the stage between raw materials and
finished goods. Such inventory can include items awaiting packaging
or quality control checks, as well as packaged items. For example, a
crayon manufacturing company could call both unwrapped crayons
and wrapped-but-unboxed crayons WIP inventory.
 Finished Goods: This is the inventory that’s ready to sell and to
generate revenue for the company. That box of crackers in your
grocery cart, or that jacket you try on at the mall, or that toy you buy
for your children — they are all finished goods.

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