Inventory in manufacturing companies generally cycles through four distinct stages: raw materials, work-in-process, finished goods and the cost of goods sold. Unlike wholesale and retail companies, manufacturing companies must account for inventory before it is ready for sale along with all the costs associated with getting that inventory ready for sale. While the first three stages are listed as notes to the balance sheet, the cost of goods sold is a line item that can be found on the income statement just after sales.
"Raw materials" is the first stage of inventory. These are the materials that will make the final product and consist of the most basic goods such as wood, metal and water. For example, the raw materials for a pet food supplier may consist of grains, vegetables, meat, water and fruit.
Once raw materials are pulled into the process of creating a final product, they enter the next stage of inventory, which is called "work-in-process." Work-in-process includes all products that are yet to be finalized. The costs associated with work-in-process inventory are the cost of raw materials, the cost of the labor used in production and any manufacturing cost -- including overhead -- that can be directly tied to the product. Since overhead includes many items that cannot be directly tied to the production of a single unit, these costs are allocated as a percentage based on historical overhead costs and include things such as rent, utilities, and the depreciation of property, plant, and equipment.
At the completion of the manufacturing process, all costs associated with production, including raw materials and work-in-process costs, are transferred to the next stage of inventory: finished goods. Goods sit in the finished goods stage until they are sold. Costs associated with inventory obsolescence, loss in value due to market demand and even the loss of product due to theft, or shrink, are also included this stage.
The first three stages of the inventory process are part of the balance sheet and are valued as company assets. Once the final product is sold, it is transferred from the balance sheet to the income statement and included in the cost of goods sold account.