Inventory Control Tips for Manufacturers, Wholesalers, and Distributors
Inventory management is a critical component of running a successful manufacturing, wholesaler, or distribution enterprise. Many great software programs, integrated scanning tools, and apps will provide the technology to record the details and create efficient workflows. But as with any tools, they need good input data to be useful.
Consistency, good accounting procedures, and physical counts will yield accurate input data, which in turn benefit your planning, forecasting, and financial reports.
Consistency is a key factor in inventory management.
- Choose and be consistent in your inventory method: FIFO (First In, First Out), LIFO (Last In, First Out), or average cost method. If you use an inventory management software program, you will choose your method at the time of setup, and the system will track your inventory with that method. If you are tracking inventory manually, continue with the same method once you switch to an inventory management software program. If you have not chosen one or don’t know which to choose, your accountant or your industry’s standard practices would be good places to start. There are tax consequences to each choice.
- Have your inventory or accounting system create the requisitions, purchase order documents, and receiving reports. Your software will create sequential numbers, which will be an additional control.
- Purchase requisitions: These are internal documents that your manufacturing or retail inventory control specialist (depending on your business) uses to request the purchase of parts or products. Alternately, sophisticated inventory programs can generate automatic requisitions based on things such as product demand, desired inventory turns, pre-described stock levels, lead times, and just-in-time considerations.
- Purchase Orders (POs): When the request for parts or products is approved, a copy of this document will be sent to the vendor. The internal process can be as simple as an assigned approver’s signature. If you are using software that has the capability of digital approvals, that will increase efficiencies. Set up a procedure with your vendor stating that they must include a copy of the original PO or reference the PO number on their invoice. Both the PO and the invoice will show the order quantity, items or part numbers, detailed product descriptions, and agreed pricing. Any discrepancies between the two are noted by the system and checked against receiving reports.
- Receiving Reports: Ideally, your warehouse staff will enter counts manually into your software, or if you are using SKU (Stock Keeping Unit) numbers, scan the items with the quantities into your software at the time of receipt. Your software can generate the receiving report as an additional backup of what was received.
Accounting Procedures: Reconciling the Counts and Costs
Assign which department or staff member will resolve quantity or cost differences with the vendor. Decide if you want to place unavailable items on backorder, find a new vendor, or seek a substitute. Tell your vendors how you wish to be notified of price adjustments and delays. Update prices in your system.
The accounting staff will then reconcile quantities received and agreed costs with the invoice from the vendor. Create an accounting procedure for discrepancies.
- The accounting staff will send the PO with a copy of the invoice to the purchasing department or be assigned to call the vendor for an updated invoice.
- Your accounting staff will short-pay the invoices so the vendor will receive the payment in time to meet the due dates. In that way, you’re letting their accounting department initiate the adjustment, and your company is not past due.
If you are using accounting software with inventory capabilities, be sure to have a procedure in place when creating or updating new items. Make sure that purchases are booked to the asset account and sold inventory is charged to the cost of goods (sold). This is a common error. If set up properly, this fine-tuning to the accounting software can help you avoid many inventory-tracking issues.
Physical Inventory Counts
We recommend a monthly (if possible) and at the very least a yearly physical inventory count for accurate financial reporting.
Taking periodic physical inventory counts will ensure proper accounting of the value of your inventory. How often you take this count (daily, weekly, monthly, and yearly) may depend on how large your inventory is. If you have minimal inventory, this method is done easily with little to no disruption to your business operations.
A large number of inventory SKUs may require the company to delay shipments or stop production, and this can take days and additional staff, not to mention lost sales. For these more extensive inventories, periodic cycle counts (where a representative sampling of the total inventory is counted to quantify and estimate the whole) are useful in maintaining inventory accuracy without shutting the business down. Although your software system can keep accurate counts of what comes in and goes out, it still relies on manual entry by staff and physical counting. Things happen to inventories over time.
Warehoused merchandise can be damaged, expired, lost, or stolen, all of which is known as “shrinkage.” We recommend creating a procedure to perform an inventory count for these items to document and record them properly in your accounting or inventory system. Here’s a previous LSL post on preparing and managing a physical inventory.
Forecasting and Planning
One of the benefits of an updated and maintained inventory is that it allows management to do accurate cost analysis and cash-flow projections. Since inventory is a large percentage of a manufacturing or retail business’s expense (payroll is another large expense), it is crucial to have accurate numbers and costs.
Having procedures and controls in place to update costs and counts ensures accuracy of the reporting and planning; and those numbers become an important part of business decisions. Revenues are dependent on the proper pricing of your goods in the marketplace. And inventory has a direct impact on cash flow and profitability for the whole business. For a discussion on cash flow, please this LSL post from earlier this year.
Managing your inventory counts and costs will be an important component of accurate financials. For financial reporting, you want your revenues to be correlated to the cost of goods sold (COGS). The cost of goods will be the record of your periodic inventory adjustments and the actual costs of doing business.
Your balance sheet will have a record of your current inventory asset value. Your profit and loss (P & L) statement will show costs related to the sale of the inventory.
Current and accurate documentation of inventory will reflect the current value of your business’s assets, inventory numbers, and inventory turn support. These data inform how well the business is performing, and often become very important when seeking outside financing or during M & A negotiations.
The health of your business will be tied to your inventory numbers. It’s often helpful to think of inventory like cash. Then, when you hear how inventory affects cash flow, budgeting, and profits it’s easy to see why all of those depend on the accuracy of your inventory count (a.k.a. cash). Both are assets on your balance sheet, and having a system in place to maintain accurate inventory is vital to the success and longevity of the business in these uncertain times.
Particularly if a business is growing, its historical inventory and purchasing cycles are inadequate for higher production in a manufacturing concern. In the case of retailer or distributors, an inadequate inventory that doesn’t reflect new sales levels will stunt the company’s growth. If there’s too much inventory or it’s the wrong kind, cash is tied up, and the business suffers.
Not too much. Not too little. Good inventory controls will make your inventory levels “just right.”
inventory and cash control