How to understand raw materials inventory

Definition

Raw materials inventory is the unused stuff a maker has bought to build a product. On the books, this is a current asset inside inventory, not an expense and not work already underway.

The materials sit on the Balance Sheet until production takes them. Only after they are used, and the finished goods later sell, does the related cost reach the profit and loss statement as cost of goods sold.

A candle workshop counts soy wax, fragrance oil, and unused wicks here. Those items are still in the storeroom, not in a pouring pot.

This line is for production inputs that have not been issued yet. It is not the half-poured batch, and it is not the finished jar on the shelf.

Where it shows up

Balance Sheet: Located in the current assets section, inside inventory.

P&L: Related to cost of goods sold after the materials are used and the finished goods sell.

Cash flow: Increases in this account, reported cash from operating activities decreases.

See also: Inventory · Work In Process Inventory · Direct Materials

When you look at your Balance Sheet, raw materials inventory sits inside inventory, in current assets. When this account is high, cash is often sitting in unused wax, lumber, or fabric; when it is low, production may be close to running out.

The profit and loss statement does not list raw materials as a line. The related cost waits until the materials are used and the finished goods sell.

On the Statement of Cash Flows, paying the supplier is the cash event. Cash from operations falls when you pay, and this account rises until production takes the materials.

A packing slip or goods receipt is how many shops confirm what actually arrived. The purchase order is the earlier document that said what you meant to buy.

How it works

A typical path starts with a buy. You place a purchase order, the vendor ships, and you record what landed.

If you buy on credit, raw materials inventory and accounts payable both go up. Cash has not moved yet.

If you pay on delivery, this account goes up and cash goes down. The assets just change mix.

Freight, duties, and other inbound costs often join the unit cost. That full amount is what many books call landed cost, and it stays with the materials until they leave this account.

The materials wait in the storeroom. Nothing hits the P&L yet, because you still have the wax.

When production needs them, you issue the materials out of this account. The cost moves into work in process, still as inventory, now attached to units being made.

This account is not the same as every material you will ever buy. Spare parts for a machine, or office paper, usually sit somewhere else.

A reorder point is the stock level that tells you to buy again. It is a planning number, not a Balance Sheet line.

Example

A candle workshop buys $800 of soy wax and $200 of fragrance oil from a supplier, due in 30 days.

The workshop records:

Debit: Raw materials inventory $1,000

Credit: Accounts payable $1,000

Raw materials inventory (an asset) and accounts payable (a liability) both go up by $1,000. Cash has not moved.

The Balance Sheet is larger on both sides. The profit and loss statement has not changed, because the wax and oil are still in the storeroom.

Later the maker issues $300 of wax to the pouring bench.

Debit: Work in process inventory $300

Credit: Raw materials inventory $300

This account falls by $300, and work in process rises by $300. Total inventory is unchanged; the materials have only moved into production.

Common mix-ups

Raw materials inventory is not work in process. Unused wax in the storeroom sits here; wax already in a pouring pot has left this account.

Buying materials is not an expense yet. The cost stays in this asset until production uses the materials and the finished goods later sell.

Direct materials are the inputs you can trace to a product. This account is where those unused inputs wait, not the name of the cost after they have been used.

Related terms

• Inventory: Goods held for sale or used to produce goods for sale.
• Work In Process Inventory: Partially completed goods still moving through production.
• Direct Materials: Materials that can be traced directly to a finished product.
• Purchase Order: The document authorizing a purchase from a vendor at agreed terms.
• Goods Receipt: The record confirming that ordered goods actually arrived.
• Landed Cost: The full cost of getting a purchased item to your door, including freight and duties.
• Inventory Valuation: The method used to assign cost to units held and units sold.
• Reorder Point: The stock level that triggers a new purchase order.