Exploring Basic Components: Definitions, Bookkeeping, Classifications, and Purposes of Raw Materials
Raw materials are essential substances or inputs used in the primary production or manufacturing of goods by companies. These can range from steel and oil to corn, grain, and even water. Examples include steel, oil, corn, grain, gasoline, lumber, forest resources, plastic, natural gas, coal, minerals, and various plant and animal-derived resources. Mined raw materials include ores, stones, metals, minerals, lime, sand, soil, oil, and coal. Plant-based raw materials come from trees or plants, including fruits, nuts, flowers, vegetables, resins, wood, cotton, and latex. Animal-based raw materials are extracted from animals such as milk, meat, furs, leather, and wool.
Manufacturing companies handle raw materials inventory with detailed accounting methods, considering costs like shipping and storage for accurate budgeting and financial reporting. Raw materials are categorized into direct and indirect. Direct raw materials are used directly in making a product and are expensed on the income statement within cost of goods sold. Indirect raw materials, on the other hand, support the production process but do not directly appear in the finished product. Examples include fittings, nails, wood glue, and equipment for workers.
Raw materials are often related to natural resources, and manufacturing companies may not want to directly invest in extracting them. Instead, they may rely on suppliers for these materials. In Germany, key raw material suppliers include companies like BASF, Bayer, and Dow Deutschland in the chemical and raw materials sector. These companies primarily deal with fossil-based substances like naphtha and petroleum derivatives. Other important sectors rely on suppliers such as K+S (potassium salts and fertilizers) and major food industry suppliers like Premium Food Group for agricultural raw materials. Germany also seeks strategic partnerships for critical raw materials such as rare earth elements, e.g., with Canada, to reduce dependence on China.
When a company uses raw materials inventory in production, it transfers them from the raw materials inventory to the work-in-process inventory. This inventory classification represents the goods being produced at a particular stage of the manufacturing process. There are three distinct inventory classifications on a company's balance sheet: raw materials inventory, work-in-process, and finished goods.
Raw materials inventory is valued at its comprehensive cost, including shipping, storage, and preparation. Direct raw materials are typically considered variable costs since the amount used depends on the quantities being produced. Companies may prepare a separate budget for raw materials when planning their annual manufacturing or production.
In the manufacturing of tables and chairs, direct raw materials include timber, wood, cushions, padding for the chairs, and cloth fabric to cover the chairs. Water can be considered a raw material used in a wide range of products and production processes.
The operations required to procure each type of raw material can be very different, so companies must be mindful of how to most efficiently source the materials. This involves considering factors like cost, availability, and environmental impact. By understanding and managing their raw materials effectively, manufacturing companies can ensure the production of high-quality goods while maintaining financial stability.
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