[I had to edit this post on April 01, 2008. And no, it’s not April Fool’s Prank]
Have you ever wondered how manufacturing scrap works? Or what it really is? It’s an interesting topic, and yet a very confusing one. It has caused so many headaches to the project team I worked on recently, because nobody really understood it. So, what is manufacturing scrap?
Due to fluctuations in market prices, purchase cost of goods may vary from one purchase to another. Also, you rarely just purchase goods and immediately sell them in the same quantity. What you usually do is that you purchase the goods, then let them sit in the inventory for a while, then you may sell five different purchases all at once, or you may sell goods from one purchase to five different customers.
All of these situations have different effects on your inventory value, because something else must be taken into account: cost flow. Regardless of the inventory valuation method you chose, whenever you take an item from the inventory, how do you know its cost? Without knowing its cost, you can’t know the cost of goods sold, so you better know your cost. Don’t tell me you stick the purchase price to each item, so that you can know exactly how much it cost whenever you are about to sell it, because accountants won’t subscribe to the idea.
When you buy a sheep, how much is it worth to you, what is its value? For starters, its value is at least what you paid for it, but that’s not quite it. Say you paid a hundred dollars for it. If you want to sell it now, how do you determine your selling price? A hundred-twenty? A hundred-fifty? Obviously, you need to increase the price by some percentage over whatever you paid initially, but regardless of what you increase your price, if you don’t know your true costs, you might be at loss.
Unless you are a non-profit, the point of the business is making money. It is surprising how many different ways of making money there are out there, but if you are in business, it is extremely likely that you make the money the easiest and the most common way around: by selling goods.
There are many ways goods come to be, but from perspective of a single business goods can be either purchased, or manufactured. But even companies manufacturing the goods they sell have to somehow get hold of the raw materials used to produce their goods. The most common way to get the raw materials for your manufactured goods is to purchase them. So in the end of the day it comes down to the simple fact that the most common way of making money is by purchasing and selling goods.
There is really nothing special with this post. I just wanted to let you know that I updated my About page, and I added some more information to the sidebar…