If your inventory seems out of hand,
you’re not alone. Even the most profitable manufacturers will struggle at times with inventory controls.
“There is a tremendous opportunity for
fraud if your inventory controls are weak,”
says John O. Heck, director, Accounting &
Auditing Group at Kreischer Miller. “Employees can set up fictitious vendors and ‘pay
themselves’ for goods never received. People
have been known to take and sell truckloads
of inventory to noncustomers. Without controls, no one at the company may recognize
the stealing.”
Equally damaging is if your manufacturing
facility builds up too much inventory, and
you do not know exactly how much product
is stored in the warehouse. Inventory takes
up space and incurs the cost associated with
that space.
Heck explained to Smart Business how to
manage each of the ‘four categories of inventory control.’
What are the basic principles of maintaining
control of inventory?
To manage inventory costs, you must
address these four areas of inventory control:
- Does the inventory you think you have
actually exist? - Is inventory in the condition you believe
it is in? Are you housing normal, slow-moving
or obsolete inventory? - Is inventory being carried on the books at
the appropriate value? - Will the level of inventory on hand
accommodate expected activity (i.e. sales)?
What implications do manufacturers confront
when determining what inventory is there
and what is paid for?
You need inventory controls that sufficiently show that the inventory you paid for is in
your warehouse, which isn’t as easy as it
sounds. This requires establishing controls in
the receiving location and physical controls
where the inventory is maintained. This system should accompany accounting controls
to ensure you pay only for items received,
which then requires matching receiving documents and invoices. Formulate regular procedures to verify that inventory is recorded on the books. That includes making cycle
counts to compare physical inventory to
what your records say. This is best accomplished with an effective perpetual inventory
system by which you keep continual track of
inventory balances, incoming and outgoing
shipments and cost of goods sold on a day-today basis. The more up-to-date and ‘real time’
your records, the better you can rely on cycle
counts as a true check on whether the inventory you think you have is actually there.
How can the condition of inventory sabotage
efficiency?
Without physical observation by someone
who knows the quality standards for your
inventory, you could be storing items that are
damaged or even obsolete. Then you may
confront a situation where you think you
have plenty of inventory, but, in fact, you do
not have the items necessary to fill orders.
Systems to ensure proper condition of inventory can range from assigning ‘inspectors’
that evaluate manufactured products and
confirm their quality standards to conducting
regular inventory checks where knowledgeable employees review all items and segregate those that are no longer relevant.
What are various ways that manufacturers
carry the value of inventory on their books?
Traditionally, manufacturers used a standard cost approach to determine the value of
inventory. This means including labor, materials and overhead for each item. Each widget is responsible for covering a proportion of
each fixed cost, and the goal is to produce
inventory for the lowest standard cost possible. This results in producing long runs of
inventory, and generally making more than
needed at one time at what appears to be a
lower cost. But, in reality, the cost of that
inventory is increasing between 20 to 35 percent annually because of the carrying costs.
An alternative to this is a direct costing
approach, common in the Lean and theory of
constraints (TOC) environments. Inventory
is viewed as a variable cost encompassing
materials. Labor and overhead are considered period costs and are expensed each
month. The key is getting materials out the
door as quickly and efficiently as possible
because only then, when goods are shipped,
does the company make money. Operations
are tweaked and refined so that items can be
produced ‘just in time’ to ship to customers.
With Lean, a large inventory is viewed as a
sickness. No inventory sits for too long. A primary focus is on reducing ‘changeover,’
which is the time between a machine producing one product and changing over to a
different product. Nimble operations that can
produce a diverse inventory with just minutes of changeover are the most profitable.
Where should companies start if they want to
make tweaks in their processes?
First, for any system to be effective, the initiative must come from the top. Executing
inventory controls requires buy-in from every
employee, from the shop floor to the back
office. There are plenty of books and consultants who can guide your company as you
adopt Lean practices or modify your inventory systems. Discuss your goals with a trusted
adviser, who can suggest a specialist. Most of
all, communicate your goals with the entire
organization.
JOHN O. HECK is director, Accounting & Auditing Group, Kreischer Miller, Horsham, Pa. Reach him at (215) 441-4600 or
[email protected].