Inventory Essentials is a two-part series. The first article focused on the basics of inventory and counting systems. This article addresses concerns you may have after completing a physical inventory or cycle count.

Your manufacturing business has completed its physical inventory or cycle count and reconciled the count to your accounting system inventory. The reconciliation may reveal that you have some issues to resolve. If this is the case, it is critical that you address these issues and prevent future reoccurrence.

Tackling Errors
Despite best efforts to ensure an accurate inventory, errors will likely occur, especially in systems that are not highly automated. First, inventory errors should be corrected in the accounting and/or inventory tracking system. The process for completing this task will be dependent on the software your company uses.

Next, determine the root cause, especially for significant errors. Consider how to prevent the issues from reoccurring. Further, think ahead to other ways that you may be able to reduce future or ongoing errors. Considerations include:

• Process improvements as your inventory flows through your system. This may include improvements to your warehouse management or production reporting system.
• Checks and balances to ensure accurate transactions. Internal controls go beyond taking an inventory count.
• Whether your physical or perpetual inventory system is right or sufficient for your inventory. There are advantages and disadvantages to both physical inventories and cycle counts.
• Possible fraud. While we do not recommend hasty accusations of fraud, it is important to rule out this potential cause of inventory discrepancies and ensure you have the controls in place to prevent it.

Obsolete or Excess Inventory
Manufacturers should consider when inventory items lose their usefulness. This may occur if inventory is damaged, beyond its shelf life, obsolete, or considered excessive. Excess inventory occurs when on hand quantities are greater than the expected usage or sales for a given period, which may vary based on your business.

Companies that face these issues on a regular basis may consider implementing a reserve to offset future write offs. Manufacturers should develop processes to help them address both financial and physical changes in inventory. It is good practice to review slow moving or obsolete inventory during your physical inventory process, if applicable, or at least once per year.

For questions or to discuss your company’s inventory, contact a member of the HBK Manufacturing Industry Group at 330-758-8613.

Inventory Essentials is a two-part series. This article will focus on a basic understanding of inventory and counting systems, while the second article will focus on error resolution and prevention.

Inventory is a critical asset. It can help manufacturers fulfill demand, reduce costs through quantity discounts, or increase profitability by improving production efficiencies. However, holding too much inventory can harm a business by depleting cash, wasting labor resources, or reducing stated profit when write offs are needed. As a result, a manufacturer must manage its inventory levels.

Types of Inventory
For most manufacturers, inventory includes:

• Raw Materials: materials or parts used to manufacture a sellable product. You likely purchase raw materials from suppliers. Think of raw materials as the “ingredients” in the product you will sell to customers.
• Work in Process (or WIP): products that are partially made or “in process”. Some but not all production processes are complete. Some companies do not have WIP inventory.
• Finished Goods: products that are complete. All manufacturing processes are finished, and these products are ready to sell to customers.

Physical Inventory vs. Cycle Counts
Verifying inventory levels is a fundamental internal control practice. For financial statement or tax purposes, you may be required to take a physical inventory even if you maintain a perpetual counting system. It is recommended that all businesses, whether required or not, confirm their inventory counts regularly. Some manufacturers perform both physical and perpetual counts. Choosing the best inventory validation process is dependent on your business, your inventory, and the processes and controls you have in place.

Manufacturers may take physical inventory counts annually, semi-annually, quarterly, or even monthly. Operations are halted, and all items – raw materials, WIP, and finished goods – are counted. Counts are reconciled with the accounting system inventory. Physical inventory counts provide a “clean slate”, which can be beneficial as you enter a new year or fiscal period. Depending on your inventory size, physical inventories can be time-consuming and costly. However, physical inventory and planned operational shutdowns can be scheduled simultaneously to reduce the impact of downtime.

With cycle counting, a sample of inventory is counted at specific times and in specific frequencies. The sample may be random or determined by other methods, such as the ABC or 80/20 method. Manufacturers should consider their business, inventory, and the support their inventory management software offers when selecting a cycle count method. Cycle counts cause less disruption than a physical inventory because a complete operational shutdown is not required. They may also improve the accuracy of inventory during the year. This may help purchasing agents make better decisions since they can better predict replenishment needs.

For questions or to discuss your company’s inventory, contact a member of the HBK Manufacturing Solutions Group at 330-758-8613.