Finished goods are any products that have gone through the production cycle and are ready to be distributed or sold by a company. They are a type of inventory.
Essentially, finished goods are finished products. However, they’re still in the company’s hands, not the consumers. Thus, finished goods— just like any other inventory— are also a part of current assets. They might stay within the company after the production process has ended, but not for long. Or, more specifically, not more than a year.
The Production Cycle
Companies that deal with producing a product will have a production cycle. In general, they convert raw materials into ready to be used products. During this process, these materials or products are divided into three categories.
- Raw materials
- Work in process
- Finished goods
Raw materials refer to the initial state of goods before going into any manufacturing process. This can range from entirely natural things, like unprocessed woods or metals, to goods bought from another company, like computer parts. In other words, one company’s finished products can become raw materials for another.
Work in process, evident from its name, is a good that has entered the manufacturing process but only partially finished. Imagine you are making a loaf of bread. You have mixed raw materials like eggs and flour, but the soon-to-be bread is currently simply a dough.
The final phase of the production cycle is finished goods. These goods are ready to be used but not yet consumed. Another party that would receive the goods— whether it’s a seller or end-user— won’t need to do any further production activity. The only exception is when the finished products become another entity’s raw materials. Thus, triggering a supply chain.
Understanding Finished Goods
For an even better picture of what finished goods are, let’s differentiate the term with other similar things. This can help you to comprehend it completely.
Finished Goods vs. Inventory
When you think about the word ‘inventory,’ what kind of goods comes into your mind? Is inventory only consists of goods that are only available for distribution or sale? The answer is no. The range of stock can amount to any property ranging from raw materials needed to create goods into completed products. This also includes everything in between, i.e., work in progress.
By definition, inventory is physical assets a company owns that can be turned into cash in 12 months or less. How about finished goods?
As mentioned before, raw materials, work in process, and finished goods fall under one category, which is inventory. All of them are assets that most likely won’t stay with a company for too long. In addition, unlike long-term assets, they are liquid or can be easily converted into cash.
On the balance sheet, there’s no differentiation between raw materials, work in process, and finished goods. All of these are recorded under “Inventory.”
As a side note, the balance sheet of a company is released at the end of every period. The “Inventory” value being reported on the sheet is the left-over inventory not yet sold during the period. In other words, this includes unsold finished goods as well as raw materials and work in progress.
At the start of the next period, all of the inventory will be treated as the beginning inventory, which is an essential indicator to calculate the cost of goods sold (COGS).
Finished Goods vs. Work In Progress
At this point, you are likely able to discern finished goods and work in progress comfortably. However, there are a couple more differences between them.
The first one is in terms of saleability. Since work in progress is just intermediary goods between raw materials and final products, this type of inventory would have far less sale value compared to finished goods. On the other hand, inventory that belongs to finished goods is ready to be sold at full price by the company.
The second difference is the naming of the term itself. A product might be “finished good” for one company. However, another company may treat the same product as “raw material” or even “work in progress.” One example is electronic components.
Your smartphone’s system-on-a-chip (SoC) is a finished good for a semiconductor company. But, the same SoC is instead acting as raw material for your phone’s manufacturer.
In conclusion, there is no absolute term to label any good. One material can be either raw material, work in process, or finished good depending on the company who owns it.
Finished Goods vs. Merchandise
Finished goods and merchandise are similar — both of them refer to products ready for sale. The only distinction is that finished goods are goods that have completed a company’s production cycle. On the contrary, merchandise is products that are purchased by a business in a completed form without needing any additional manufacturing. Let’s consider an example.
AMD is a semiconductor company specializing in creating processors for personal computers. These processors are developed and manufactured by AMD and its partners. When the manufacturing process is done, the processors become finished goods for AMD.
Afterward, the processors—which include CPUs and GPUs—would then be distributed to retailers through a supply chain. The retailers don’t make the processor themselves. They simply purchase the products and resell them to the end-users. For retailers, the processors are referred to as merchandise.
Finished goods are goods that come from the manufacturing of raw materials into completed products. When these products are only half-finished, they are referred to as work in progress. Work in progress can also be thought of as any inventory that isn’t raw materials or finished goods.
Keep in mind that finished goods and merchandise are two different things. Both of them are sell-able products. However, just from the name implies, finished goods are “completed” in the sense that they first need to go through a production cycle carried by the company that owns them. Meanwhile, merchandise stays the same from when a business first purchased them to post-sale. Retailers are usually the owner of the merchandise.