Loading the player...

What are 'Raw Materials'

Raw materials are materials or substances used in the primary production or manufacturing of goods. Raw materials are often referred to as commodities, which are bought and sold on commodities exchanges around the world. Raw materials are sold in what is called the factor market, because raw materials are factors of production along with labor and capital.

BREAKING DOWN 'Raw Materials'

Raw materials are accounted for in an intermediate inventory account used by manufacturing companies. As raw materials are used, raw materials inventory is decreased, while work-in-progress accounts are increased. When the work-in-process items are completed, they are transferred to finished goods, and are accounted for as cost of goods sold upon sale.

Direct vs. Indirect Raw Materials

Raw materials may be divided into two major classifications: direct and indirect. Direct raw materials are materials that can be directly traced to the finished product. For example, lumber may be directly traced to a completed chair, so in this situation, lumber is a direct expense.

Indirect raw materials are items that cannot be specifically traced. An example is the wood finish placed on the manufactured chair. Although the entire drum of wood finish is evident, the specific wood finish within the drum cannot be traced to the exact location on each produced chair. Raw materials may also be classified as indirect if the total dollar amount is immaterial.

Fixed vs. Variable Costs

Another major classification that can be used to describe raw materials is "fixed or variable costs." Fixed costs relate to charges that do not vary based on inputs or production levels. Variable costs relate to charges that fluctuate based on the quantity being produced. For this reason, raw materials are typically variable manufacturing costs because they are only purchased during the production of a good. If no good is being produced, the cost is not incurred, and because it can be avoided by reducing production, raw materials are a variable cost.

Direct Raw Materials Budget

A manufacturing entity calculates the amount of direct raw materials needed for specific periods, to ensure shortages do not occur. Also, with the specific amount of direct raw materials, an entity has the ability to reduce inventory stock and security, lower ordering costs, and reduce the risk of material obsolescence. The direct raw materials budget is calculated by adding the raw materials required for production to the anticipated or desired ending balance of direct raw materials. This summation is reduced by the amount of direct raw materials on hand at the beginning of the period. The final figure is the total direct raw materials that need to be purchased.

RELATED TERMS
  1. Basic Materials Sector

    A category of stocks that accounts for companies involved with ...
  2. Goods In Process

    An inventory account that is usually identified on the balance ...
  3. Work In Progress - WIP

    Material that has entered the production process but is not yet ...
  4. Value Chain

    A high-level model of how businesses receive raw materials as ...
  5. Production Cost

    A cost incurred by a business when manufacturing a good or producing ...
  6. Prime Cost

    A business's expenses for the materials and labor it uses in ...
Related Articles
  1. Investing

    Variable Costs

    Variable costs go up when a company produces more goods or services, and go down when it produces fewer goods or services. This is compared to fixed costs, which do not change in proportion to ...
  2. Investing

    The Debt Report: The Materials Sector

    Find out why the U.S. materials sector has accumulated more and more debt each year between 2011 and 2015, outstripping valuation gains.
  3. Investing

    Explaining the Value Chain

    A model of how businesses receive raw materials as input, add value to the raw materials, and sell finished products to customers.
  4. Investing

    Explaining Prime Cost

    Prime cost is a way of measuring the total cost of the production inputs needed to create a given output.
  5. Investing

    What are Top 3 Materials Equity Mutual Funds?

    Read about mutual funds covering the basic materials sector that could be excellent buys after a catastrophic 2015 for the category.
  6. Small Business

    What Does Short Run Mean?

    Short run is the concept that for a business, at least one factor of production is fixed while others are variable.
  7. Investing

    Understanding Explicit Costs

    Common examples of explicit costs include wages, utilities, rent, raw materials, and other direct expenses companies pay to conduct business.
  8. Investing

    Manufacturing Is Suffering, Consumers Don't Care

    The recent divergence between consumer sentiment and the manufacturing sector's health has continued, with a flurry of data releases Thursday highlighting this rift in the American economy.
  9. Insights

    How To Prepare For Rising Interest Rates

    Ignoring interest rates is a mistake because there are many ways to increase your income as they start to rise. The key is to be ready to act.
  10. Investing

    How to Analyze a Company's Inventory

    Discover how to analyze a company's inventory by understanding different types of inventory and doing a quantitative and qualitative assessment of inventory.
RELATED FAQS
  1. On which financial statement does a company list its raw material costs?

    Discover what items are raw materials, how raw material costs affect businesses, and where these costs are recorded on a ... Read Answer >>
  2. What is the difference between work in progress (WIP) and raw materials in accounting?

    Learn about the difference in inventory financial accounting between works in progress and raw materials, as reported in ... Read Answer >>
  3. What commodities are the main inputs for the electronics sector?

    Explore the use of commodities in the electronics sector. Discover potential risks and opportunities presented by raw materials ... Read Answer >>
  4. Does a company logo change require a material disclosable event?

    A company logo change usually constitutes a material disclosable event. Securities law requires that companies disclose all ... Read Answer >>
  5. How is work in progress (WIP) typically measured in accounting?

    Understand what work in progress is and why a company would have this on its financials. Learn how work in progress is typically ... Read Answer >>
  6. What is the difference between prime cost and conversion cost?

    Understand the difference between prime costs and conversion costs, and learn how each type is used in analyzing business ... Read Answer >>
Hot Definitions
  1. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  2. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  3. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  4. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  5. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  6. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
Trading Center