What Are Raw Materials?

What Are Raw Materials?

Let me explain raw materials to you directly: they are the basic materials or substances you use in the primary production or manufacturing of goods. These are commodities that get bought and sold on exchanges around the world. As a business owner or manager, you deal with them in the factor market because they're key factors of production.

Understanding Raw Materials

You see, raw materials show up in all sorts of products and can come in many forms. They're the input goods or inventory your company needs to make its products. Take steel for cars—that's a raw material for an auto manufacturer. If you're in manufacturing, you need detailed budgeting and special accounting for raw materials on your balance sheet and income statement.

Often, raw materials tie back to natural resources, so you're at the mercy of nature for availability. That's why many manufacturers don't invest directly in extraction; for instance, a company using oil or plastics usually doesn't own the drilling rigs.

Accounting for Raw Materials

In manufacturing, you have to handle raw materials inventory differently, with three inventory types on the balance sheet: raw materials, work-in-process, and finished goods—unlike non-manufacturers who just have one.

Value all inventory, including raw materials, at full cost, covering shipping, storage, and prep. When you buy raw materials, journal it as a debit to inventory and credit to cash, boosting current assets.

As you use them in production, move them from raw materials to work-in-process inventory. Once done, they go to finished goods, ready for sale.

Direct vs. Indirect Raw Materials

You can split raw materials into direct and indirect, which affects where they go on the balance sheet and how they're expensed on the income statement.

Direct Raw Materials

Direct ones are what you use straight in the finished product, like wood for a chair. They sit in current assets and get expensed in cost of goods sold. You need more detailed reporting on these as variable costs, tied to production volume.

Calculate your needs per period to avoid shortages—this tracks usage, cuts inventory, lowers costs, and reduces obsolescence risk. If materials go bad, write them off: debit write-offs and credit obsolete inventory.

Indirect Raw Materials

Indirect materials aren't in the final product but support the whole process. Record them as long-term assets, maybe under SG&A or PP&E. They depreciate over time, matched to revenue, usually faster than buildings.

Types of Raw Materials

Classify raw materials by extraction: mined like ores, metals, oil, coal; plant-based like wood, cotton, fruits; animal-based like milk, leather, wool. Each type demands different investments—farming differs from mining, so source efficiently.

Example of Raw Materials

Say you're making tables and chairs: direct materials are timber, cushions, fabric; indirect are nails, glue, worker tools. Direct ones trace to each unit for per-unit costing, while indirect get allocated via overhead.

What Are Raw Materials in Food?

In food, raw materials are items like meats, milk, fruits, or ingredients in recipes—milk for cheese, for example.

Is Water a Raw Material?

Yes, water counts as a raw material in products from drinks to farming and industry.

What Is the Difference Between Inventory and Raw Materials?

Raw materials are a type of inventory—goods not yet turned into work-in-process or finished products. You report them as assets, then convert them as you produce.

How Do Companies Get Raw Materials?

You strategize: partner with suppliers for reliability, or set up your own facilities. The first means ongoing costs; the second, big upfront investment but potentially lower operations.

The Bottom Line

Raw materials are the core inputs for creating sellable products, crucial to the global economy and trade. Natural resources as raw materials boost exports and GDP. You can trade them on commodities markets as a business or investor.