The balance sheet of a manufacturing company is made up of the number of assets it owns, along with the capital and liabilities, equity of the owners, etc. at a given point in time, which is generally the year or month – end. The balance sheet more or less shows the owners and the external parties what the company owns and owes. Note that the reason the balance sheet has been named such is due to the governing nature of the accounting equation, which has to balance the assets with owners’ equity and liabilities.
For manufacturing companies, generally accepted accounting principles state that simply listing a balance of inventory isn’t enough. Companies are expected to disaggregate the inventory balance into its component parts. A manufacturer’s inventory is expected to be reported in the current assets section of the balance sheet and in the notes to the financial statements.
Note that in the current assets section, the amount of the manufacturer’s inventory will be positioned after cash and cash equivalents, short – term investments, and receivables. If the sum of the manufacturer’s inventory categories is listed in the current assets section, then the notes to the financial statements will report the detailed amounts for raw materials and supplies, work – in – process and finished goods.
However, the notes to the financial statements will also express how the manufacturer’s inventory is valued. For example, the notes will disclose whether FIFO lower of cost or net realizable value, LIFO, weighted average, or other cost flow methods were used. If LIFO is used, then the excess of current cost over LIFO cost is also disclosed.
Inventory balances make a up a large percentage of many small business balance sheets, and understanding the types of inventory that are reported on manufacturing company balance sheets can help make this task much less daunting. There are four major types of inventory that are reported on a Manufacturing Business balance sheet, these inventories include;
What Type of Inventories Does a Manufacturing Business Report On the Balance Sheet?
Direct Materials Inventory (Raw Materials)
On either the face of the balance sheet or the footnotes to the financial statements, manufacturers are expected to state the direct materials inventory balance. Thus direct material, also called raw materials, are the unprocessed ingredients that the company uses to make final products.
Note that these materials have not yet been used or converted by the company’s labour and overhead into viable products. For instance, a small business in the auto part manufacturing industry may have steel and glass as part of raw materials inventory. Partially or fully completed auto parts would not be considered part of the raw materials inventory.
This commonly refers to the inventory that has been partially, but not fully completed. In the process of conversion, raw materials inventory is converted into work – in – process inventory through the company’s labour and overhead. However, depending on the type of manufacturing, small businesses may have very different amounts of work – in – process inventory.
For instance, a manufacturing business with a short production cycle that does not produce around the clock may finish production before the company completes the annual inventory count. Have it in mind that this would leave little to no work – in – process inventory. In contrast, a company that has a long production cycle, such as a bridge builder, may have the majority of the inventory balance be considered work – in – process.
This inventory refers to the inventory that has been completed and is ready for sale to customers. Remember that this inventory started in the company as raw materials, flowed through work – in – process inventory and arrived as finished goods through the conversion process.
Even though small businesses prefer to have adequate stocks of inventory on hand, they also try to manage finished goods inventory to appropriate levels. Note that having extra inventory on hand is costly in two ways.
Stored inventory represents time and resources that were used by the company before business needs necessitated their use. Also, storing inventory can be quite costly and if production could have waited, the cost doesn’t add value to the organization.
This simply means the inventory that the company still owns, but has been chosen to have little to no value. Companies that have material reserves for obsolete inventory are expected to disclose the reserve on the face of the balance sheet or the footnotes of the financial statement. The threat of obsolete inventory varies depending on the industry and type of products the small business manufactures.
For instance, good service businesses are more concerned about the threat of spoilage and technology companies may be stuck holding computer parts that become obsolete quickly. Manufacturers of consumer goods typically hold less obsolete inventory.
Other Items a Manufacturing Business Report Can on the Balance Sheet
Here are other items that form an essential part of a balance sheet of a manufacturing company.
Liabilities in the manufacturing industry more or less refer to financing that is used to buy the assets in the first place in order to produce the goods. In the form of short – term liabilities, the manufacturing companies are expected to show one or more credit lines, which were used to finance the buying of working capital and raw materials.
Note that working capital is the amount gotten after deducting the current liabilities from the current assets. Advance payments or customer deposits in the form of prepaid are often termed as short – term liabilities. On the other hand, mortgages, machinery and equipment loans are defined as long – term liabilities.
Assets are simply the resources owned by the companies which can be converted into cash. Manufacturers divide these assets in the form of fixed, short and long – term, current, and other assets. Note that when it comes to the current assets, they tend to mostly include the finished goods and work – in – progress goods, along with the raw materials which are a part of the inventory. The long – term assets comprise of equipment handling like industrial pushcarts and forklifts.
Also note that the fixed assets are defined as assets which include heavy machinery which is used to manufacture the products and any building or land in the form of a warehouse and factory which cannot be moved. Self – financing for specific orders of some customers form note receivables and can be considered as ‘other assets’ for the manufacturers.
Have it in mind that accumulated depreciation holds a lot of significance in the manufacturing industry as most companies own long – term assets. This accounts for wear and tear, along with the useful life of a long – term asset. Note that when it comes to depreciation usage, it is all about the way a manufacturer shifts an asset’s cost portion to the manufacturing financial statements of the balance sheet. Normally, the summarized yearly depreciation amount in the form of accumulated depreciation is subtracted from the original cost of the asset.
Assets in the manufacturing industry in form of prepaid bills, cash, and accounts receivable, coupled with liabilities like accounts payable are similar in all other industries. However, aside this, equity of manufacturers in the form of retained earnings, paid – in capital, and initial capital contributions hold a lot of importance in the balance sheet of a manufacturing company.
Have it in mind that the balance sheet of a manufacturing company is its backbone, and no company can make efficient decisions without maintaining the balance sheet. A well documented manufacturing company balance sheet has the potential to take the company towards business growth, while a negative balance sheet can bring down the company’s value in no time. Nonetheless, the various balance sheet essentials pinpointed above hold a lot of importance and should be managed adequately.