How to Project Inventory in the Manufacturing Industry

In the manufacturing industry, the investment in inventory is significant.

In many instances inventory in the manufacturing industry is financed by borrowings from a financial institution. Protecting inventory is a major factor in profitability and management is responsible for developing and maintaining adequate internal controls so that inventory items are safeguarded from theft or other types of misappropriation by employees or outsiders.

In the manufacturing industry a company can have 3 types of inventory:

The items that need to be considered are:

1. Raw materials
2. Work in Process
3. Finished Goods

The first step a company should take is to invest in a perpetual inventory system that can adequately record inventory items. This system will track these items throughout the manufacturing process to capture the material, labor and overhead allocated to a finished product once it is available for sale to customers. The company will need to have adequate accounting staff to record the acquisition, production processes and sale of the finished product.

Once the company has an inventory system in place, a physical inventory count will have to be performed periodically to verify that the inventory items that are actually on the warehouse floor match the items reported by the perpetual inventory system.  These physical counts can be done on a cycle basis or at set times such as quarterly, semi-annually or on an annual basis. If there are discrepancies the company/accounting staff will have to investigate and determine the reason(s) for the discrepancies. The employees investigating the differences should be individuals who are not involved in the counting process. Good practices include maintaining inventory in a locked storage area. A requisition system should be enforced in order to obtain raw materials. The requisitions should be approved by supervisors and

the quantities need to be denoted and verified when received. Requisitions should be numbered in sequential order and any gaps in the numbering sequence should be investigated.

The inventory system will track inventory items that are being produced and upon completion a report will be prepared and approved as to how many finished products are completed and forwarded to the finished inventory storage area. Sales orders must be prepared for all customer orders.

These orders should be approved and then processed by the shipping department.

Some indications of inventory theft are:

1. Missing packing slips and sales receipts.
2. Missing requisition forms.
3. Spikes in the number of damaged goods or a sharp drop in sales.
4. Discrepancies in actual inventory count versus the inventory system report.

A few ways to prevent inventory theft are:

1. Keep all storage areas locked and control/restrict access to these areas.
2. Install video monitoring.
3. Run background checks on potential employees.

If you are experiencing inventory shortages, you should consider having an independent review of your inventory system to determine if your procedures and processes are adequate to prevent fraud.

If you need help to determine if your company is experiencing fraud or need assistance in setting up a strategic plan to prevent fraud, call LSL CPAs (714) 672-0022.