Semi finished goods: Meaning, Criticisms & Real-World Uses

What Are Semi-finished goods?

Semi-finished goods, also known as intermediate goods or sub-assemblies, are products that have undergone some processing in the manufacturing process but are not yet complete for final consumption or sale to the end customer. These goods serve as inputs for further stages of production to become finished goods. They are a critical component within a company's inventory management system, representing value added beyond raw materials but prior to final assembly or packaging. Semi-finished goods are recorded as current assets on a company's [balance sheet](https://diversification.[⁵⁴](https://letstranzact.com/blogs/semi-finished-goods), ⁵⁵

History and Origin

The concept of semi-finished goods emerged naturally with the evolution of complex production processes and the division of labor that characterized the Industrial Revolution. As manufacturing shifted from artisanal production to large-scale factory systems in the 19th century, the need to track and value goods at various stages of completion became essential for efficient operations and accurate accounting.⁵², ⁵³ The development of sophisticated cost accounting methods allowed businesses to systematically assign costs to these intermediate products, providing better insights into profitability and resource allocation across different departments or production lines.⁵⁰, ⁵¹ This classification became increasingly important as global supply chains became more intricate, necessitating clear definitions for components exchanged between different entities or internal divisions.⁴⁸, ⁴⁹

Key Takeaways

Semi-finished goods are partially completed products that require further processing to become final products.⁴⁷
They represent value added to raw materials through labor and manufacturing overhead.⁴⁶
These goods are held as inventory on a company's balance sheet and are crucial for managing production flow.⁴⁴, ⁴⁵
Proper classification and valuation of semi-finished goods are vital for accurate financial reporting and operational efficiency.⁴², ⁴³
They are not counted in a country's Gross Domestic Product (GDP) to avoid double-counting, as their value is embedded in the final product.⁴¹

Formula and Calculation

The valuation of semi-finished goods on a company's financial statements involves accumulating the direct costs incurred up to their current stage of completion. The cost typically includes:

\text{Cost of Semi-finished Goods} = \text{Direct Materials Used} + \text{Direct Labor Applied} + \text{Allocated Manufacturing Overhead}

Direct Materials Used: The cost of raw materials that have been directly incorporated into the semi-finished product.
Direct Labor Applied: The wages of workers directly involved in transforming the raw materials into the semi-finished state.
Allocated Manufacturing Overhead: A portion of indirect manufacturing costs (e.g., factory rent, utilities, indirect labor) systematically assigned to the products being manufactured.

These production costs are continually tracked as the item moves through various stages of the manufacturing process until it becomes a finished good.⁴⁰

Interpreting the Semi-finished Goods

Understanding semi-finished goods provides critical insights into a company's operational efficiency and financial health. A high volume of semi-finished goods could indicate bottlenecks in the manufacturing process, inefficient production scheduling, or an imbalance between various production stages. Conversely, an optimally managed level of semi-finished goods suggests smooth transitions between production phases and effective utilization of resources.³⁹

For financial analysts, the value of semi-finished goods on the balance sheet provides a snapshot of the capital tied up in ongoing production. Comparing this figure over time, or against industry benchmarks, can reveal trends in production cycles, inventory turnover, and overall liquidity. It also helps assess the efficiency of a company's supply chain and its ability to convert inputs into sellable products.³⁸

Hypothetical Example

Consider "Alpha Auto Parts," a company manufacturing car engines. To produce a complete engine (a finished good), Alpha Auto Parts first manufactures various sub-assemblies. One such semi-finished good is the "Engine Block Assembly," which involves casting raw metal, machining, and assembling several internal components like pistons and crankshafts.

Suppose in a given month, Alpha Auto Parts incurs the following costs for its Engine Block Assemblies:

Direct Materials (metal, small parts): $50,000
Direct Labor (machinists, assemblers): $30,000
Allocated Manufacturing Overhead (factory utilities, supervisor salaries): $20,000

The total cost accumulated for the Engine Block Assemblies, considered semi-finished goods, would be $100,000. This amount would be recorded in Alpha Auto Parts' inventory as semi-finished goods. Once these assemblies move to the final engine assembly line and are combined with other components (like electrical systems, exhaust manifolds), they cease to be semi-finished goods and become part of the cost of the finished engine. This detailed tracking is essential for determining the accurate cost of goods sold for the final product.

Practical Applications

Semi-finished goods are fundamental to the accounting and operational practices of manufacturing businesses. Their effective management has several practical applications:

Inventory Valuation: Companies must accurately value their semi-finished goods for financial reporting. This involves applying specific valuation methods, such as First-In, First-Out (FIFO) or Weighted Average Cost (WAC), to assign a monetary value to the partially completed items.³⁶, ³⁷ The Internal Revenue Service (IRS) provides guidelines for inventory valuation for tax purposes.³⁵
Production Planning and Control: Tracking semi-finished goods allows manufacturers to monitor the flow of materials through the manufacturing process. This helps identify bottlenecks, optimize production schedules, and ensure that the right components are available at each stage to meet demand for finished products.³⁴
Cost Management: By understanding the accumulated production costs embedded in semi-finished goods, businesses can analyze and control expenses at various stages, improving overall cost efficiency.³³
Supply Chain Resilience: In an increasingly interconnected global economy, the movement of components and semi-finished goods across complex supply chains is critical. Disruptions, such as those highlighted during recent global events, can significantly impact the availability and cost of these intermediate products, underscoring the need for robust inventory strategies.³² Reports from institutions like Reuters frequently discuss how supply chain challenges impact manufacturing inventory levels.³¹

Limitations and Criticisms

While essential, managing semi-finished goods comes with inherent limitations and potential criticisms:

Valuation Complexity: Accurately valuing semi-finished goods can be challenging. Unlike raw materials or finished goods, which have clearer market prices or production costs, the value of a semi-finished item is based on the proportion of completed work, which can be subjective and difficult to precisely measure.³⁰ Choosing an inventory valuation method (like FIFO or WAC) impacts the reported value and, consequently, a company's financial statements and tax liabilities.²⁸, ²⁹
Obsolescence Risk: Like any form of inventory, semi-finished goods are subject to the risk of obsolescence. Changes in product design, market demand, or technology can render partially completed components unusable, leading to write-downs and financial losses.²⁷
Tied-Up Capital: Holding excessive amounts of semi-finished goods means significant capital is tied up in inventory rather than being available for other business operations or investments, impacting a company's liquidity.²⁶ Supply chain disruptions, for instance, can lead firms to hold higher levels of intermediate inputs as a buffer, which ties up more capital.²⁵
Storage and Handling Costs: Storing and managing semi-finished goods incurs costs, including warehousing, insurance, and potential damage or theft. These carrying costs can erode profitability if not managed efficiently.²³, ²⁴

Semi-finished goods vs. Work-in-Process

The terms "semi-finished goods" and "work-in-process" (WIP) are often used interchangeably, but there's a subtle distinction that can be important in detailed inventory accounting and supply chain management.

Feature	Semi-finished Goods	Work-in-Process (WIP)
Definition	Partially completed products that have undergone distinct, identifiable stages of the manufacturing process and can be stored or even sold as components to other manufacturers. They are often sub-assemblies or intermediate components.²¹, ²²	Goods that are currently undergoing active transformation within a specific production stage. They are still "on the factory floor" and are typically not yet at a point where they could be easily stored or sold as a discrete component. WIP is generally more fluid and less discrete than SFGs.²⁰
Stage of Completion	Represents a more defined and often completed stage within the overall production, often a standalone component that could theoretically exist outside the immediate flow to the next step.¹⁸, ¹⁹	Refers to items that are actively in the midst of transformation, spanning from raw materials to nearly finished goods but not yet reaching a distinct, measurable, or storable milestone.¹⁷
Storability/Transfer	Can typically be stored in inventory for a period, or even transferred/sold to another company as an intermediate product.¹⁵, ¹⁶	Generally not stored for long periods; they are in continuous motion or awaiting the next immediate step in production.¹⁴
Example	A completed car engine that will be installed into a car; a manufactured circuit board for a computer.¹³	A car chassis moving along the assembly line with parts being attached; a computer chip in the etching or testing phase.¹²

While the distinction can be subtle, semi-finished goods imply a greater degree of completion and often a more tangible, measurable unit than WIP, which encompasses all inventory currently in the midst of transformation.¹¹

FAQs

What is the difference between semi-finished goods and finished goods?

Semi-finished goods are partially completed products that require further processing to be ready for sale to the end consumer.⁹, ¹⁰ Finished goods are products that have completed all stages of the manufacturing process and are ready for distribution and sale.⁸

Are semi-finished goods included in GDP?

No, semi-finished goods (also known as intermediate goods) are generally not included in the calculation of Gross Domestic Product (GDP).⁷ Their value is already incorporated into the final value of the finished goods they become, and including them separately would result in double-counting and an overestimation of economic output.⁶

How are semi-finished goods valued?

Semi-finished goods are valued by accumulating the production costs incurred up to their current stage of completion. This includes the cost of direct raw materials, direct labor, and allocated manufacturing overhead.⁵ Companies typically use inventory valuation methods such as FIFO (First-In, First-Out) or Weighted Average Cost (WAC).⁴

Why are semi-finished goods important for businesses?

Semi-finished goods are crucial for efficient inventory management and production planning. They allow manufacturers to streamline the manufacturing process, accelerate time to market, and maintain better control over costs by enabling tracking and valuation at intermediate stages.³ They also provide flexibility, allowing businesses to adapt to changing market demands or supply chain disruptions.²

Can a semi-finished good for one company be a finished good for another?

Yes, this is possible. For example, a specialized component manufacturer might produce circuit boards as their finished goods and sell them. However, for a computer manufacturer, these same circuit boards would be considered semi-finished goods (or intermediate inputs) that are then integrated into a final computer product.¹