Inventory systems can make or break your business, and effective controls help provide visibility as to what you have, what you need, what you don’t need and costs.
But bad procedures can lead to numerous problems, including a lack of knowledge, missed production, lost customers and money wasted on carrying inventory that is not necessary.
“Inventory can be the lifeblood of a company,” says William R. Harrod, vice president, team lead, Special Assets Group with Fifth Third Bank. “It’s important to have clean systems with solid procedures and controls so you know what you have, what you need, how much it costs and how much you can make on it.”
Smart Business spoke with Harrod about how to develop effective inventory controls and how your bank can help you in the inventory control process.
How do you put effective inventory controls in place?
Let’s say you buy some widgets and use those to combine with other widgets to make a new widget to sell. It’s important to understand how many widgets you need, how many you have, how you are going to put them together and how they’re selling.
Inventories are usually tracked via perpetual systems that keep tabs on all the raw materials coming in, work in process, finished goods being produced and then removed when shipped to the customer. The perpetual system will track the location, quantity and cost, among other things. The perpetual systems today are very sophisticated and incorporate bar codes, optical scanners and the like.
Then you consider cost. This can be done various ways, including average cost, actual cost, weighted average cost and standard cost. You have to factor in the value increase as the raw material morphs into the finished product and other costs such as machines used, lights, energy and personnel.
How do you maintain effective inventory controls?
You need to work with your CPA to put together an appropriate tracking plan/system, which will vary based on the industry and the type of inventory you have. You then develop a plan policy and procedures around the system.
Some companies have automated procedures, placing a company-specific bar code on the inventory that is read optically, which takes out the human error. The key is to have a detailed plan, policy and procedures to make sure everything happens correctly every single time. Once something gets out of whack, it can mess up your production schedules, ordering schedules and financial statements.
You then need to develop an audit and review process, typically done periodically to review all procedures to make sure they’re being adhered to. An effective method is cycle counts, where you select a sample of inventory each month to test and make sure the quantity and cost are right. If you find a problem, you can expand the tests, isolate the problem and resolve it now before the system gets too out of whack.
Some companies that don’t have a lot of inventory will do full physicals and count every single piece of inventory each month. The whole process is designed to make sure systems are being adhered to and yielding the correct results. Any piece of inventory that you buy but don’t need or sell is costing you money. You want to buy only what you need in order to meet your customers’ needs.
If you see a problem during the audit, do you need to fix your procedures?
Absolutely. A lot of times during cycle counts, you will find that someone is being careless within the process, so you need to establish new protocol so that doesn’t happen again.
For example, let’s say you have 15 baseball bats but only find 10. You find out the missing bats were shipped, but no invoice was issued, meaning the customer wasn’t billed and it was never taken off the inventory. You need to go back and revise the plan so that doesn’t happen again.
What role do banks play in the inventory control process?
Banks lend on assets and will routinely send out field examiners to review systems, accounting, receivables and inventory to monitor and understand the performance of the working capital assets. From an inventory perspective, banks want to understand the composition of inventory such as raw materials, work in process and finished goods. In addition, a bank will want to understand how the company’s products are produced and tracked.
They want to understand the tracking system, costing process and how these are accounted for. They will review inventory turnovers and look to understand the company’s slower-moving and/or obsolete inventory. They will perform test counts and costs tests (similar to cycle counts).
These periodic reviews can help companies identify areas that need to be improved and also help to uncover ways for the company to improve the performance of its inventory.
It’s important to have solid systems and procedures in place. Companies that do a good job can yield more availability on inventory and may generate more borrowing capacity.
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