Aligning Inventory Reserve Policies with Asset Based Credit Availability Rules
Aligning internal inventory reserves with asset based borrowing rules requires matching stock write-down schedules directly to bank ineligible triggers.
Work in Progress Reserve
Meaning
Financial provision created to account for the reduced liquidity and higher risk associated with partially finished goods. Maintaining a work in progress reserve ensures that the reported value of inventory reflects the costs required to complete the items. This reserve acts as a safety margin for lenders who might have to finish and sell the products in a default scenario.
Completion Cost
Transforming raw components into a final product requires a significant investment in labor and overhead. The work in progress reserve represents the estimated amount of money still needed to bring the current assembly line to a shippable state. As goods move closer to completion, the reserve for those specific items may decrease.
Value Impairment
Liquidating a factory during an active production run is much more difficult than selling finished stock. When the work in progress reserve is calculated, auditors look at the difficulty of selling sub-assemblies to other manufacturers. In many cases, these items have almost no value outside of the specific factory where they are being built.
Conversion Risk
Transitioning a new design from a prototype to a full production yield involves a vast array of potential failure points that must be documented and mitigated before the assembly line begins to scale up to its maximum demonstrated rate. A work in progress reserve must be larger for complex products with many stages of assembly. If the company calls a run production-ready too early, the reserve might not be enough to cover the high cost of defects or rework.
The boundary of the reserve is where the goods are finally inspected and moved to the finished goods warehouse.