Inventory and reserves…
In many businesses, inventory is the largest part of your assets. The money you have earned or invested to support your company. Unfortunately, many companies find that they have inflated inventory numbers and have to make yearend adjustments that decrease their profitability.
Practice these next three steps to reduce your inventory challenges.
Three Inventory steps you should have in place –
1. Defined purchase process.
2. Stockroom or inventory review.
3. Managing a reserve.
Establish a good purchasing process. Why is this so critical? In many businesses, inventory is the first or second largest expense. That means that most of your cash is tied up in the stockroom, on the store shelves or in the warehouse. So, if you are going to spend most of your money on one thing, it only makes sense to have a method that guides that spending. If you are a manufacturer you may have a software solutions such as an MRP or ERP that makes suggestions based on forecast demand and usage. In other cases, it is driven by history or price (a years-worth versus 3 months for a better price). However, buying 4X what you need at any point in time should come with some significant savings. Is your expectation defined? A good process contains the following elements:
A. Who can make the decision and at what level by dollars purchased. For example, a manager or supervisor may be able to purchase up to say $500 without added approvals. However, for greater expenses, leadership must sign off and review the details including savings and where it can be stored.
B. Verification that you actually got what you paid for. Seems logical but often the amount received may be short or have other items not ordered. These should be addressed immediately.
C. Payment of an invoice for goods should be matched against the PO and the packing slip. This is often referred to as a “three-way match”.
Make inventory a monthly review. We all check our bank statements monthly for incorrect charges or deposits that did not clear. Check your inventory as closely. If it goes up significantly, ask yourself does this make sense? Or was there a big sale that depleted your inventory? This is called the “makes sense” test. Lastly, go out and look at it (Gembitsu – go and see from the Japanese lean world). Is it real and in good order? Remember this is your money!
Use this accounting technique to limit the damage that inventory can inflict. Create a reserve. It creates a way to tip the scales in your favor. Any business that has inventory whether a bakery, manufacturer or retailer can benefit from this. Here is what you do. Within your budget add a line item in your cost of goods sold (COGS) called inventory reserve. Use a percentage of your material cost of say 1-5% depending on your volatility from these types of factors.
• Loss (material that is spilled and not reported)
• Theft (shoplifting and internal theft can take their toll)
• Unit discrepancies (purchases of bushels but selling in each)
• Obsolete (things change and last year’s stuff is not as desirable)
This step will reduce your monthly profit by a little to address the above. Let’s say your annual reserve amounts to $12,000. That is only $1000 per month. Now at year end when you verify your inventory with a physical count and are short $4500. Guess what? You are covered and actually can recognize the balance of the reserve generating a $7500 profit gain.
Take your business up a notch and add the above steps to your business to assure the value of your money.
PS- It helps if you have a borrowing formula that triggers off of inventory. Showing your banker that you have control and tools to monitor this can help you increase your borrowing power.