Inventory Management: Keys to a Lean Operation
Longer timelines are often a natural part of manufacturing anything. Unlike ready-made items or services, there are multiple steps — you may spend months sourcing raw materials. You have to make it, build your assembly line or manufacturing method, and actually produce it.
There may be delays in quality control and retooling, as well as labeling and packaging. Complex manufacturing timelines mean that the accounting process is more complicated than for other enterprises. You need to take into account not just one inventory but perhaps many — for both parts or materials and the finished product.
There are accounting decisions to be made that affect how your business is perceived; for example, some businesses consider inventory an asset. But inventory requires cash — how you handle this in your books and in practice can make a difference on your bottom line.
If you run lean and purchase only as much inventory as you need to have on hand, you’re more cash-rich — not committing your finances until you need materials. Think about the costs of materials and the costs to convert those materials into products. This is necessary in order to understand the amount of inventory you hold.
Direct material inventory is a calculation of all the materials your manufacturing business is using to make your product — all the materials consumed or identified with your product. This is often listed in a bill of materials that itemizes quantities and costs of the materials used in your product.
On a typical manufacturing balance sheet, you should have raw materials, work in process and finished goods as part of your inventory calculation. You’ll want a perpetual inventory system to track how many products you have in your production line at any time.
Inventory management is crucial.
You’ll want to have a value associated with the number of goods in your inventory. Valuing your inventory will help establish the costs of goods sold and how much profit you’re making. Having a shortage or excess inventory directly affects production and profitability.
Inventory is continually being sold and restocked, so make a cost flow assumption.
- First in, first out, or FIFO — Products are sold in the order they are added to inventory. It’s a popular way of costing inventory, especially if you have products with a shelf life.
- Last in, first out, or LIFO — Operates under the assumption that the final product added to a company’s inventory is the first one sold.
- Average cost — Weighted average of all products to determine and track inventory. It works where it’s difficult to assign costs to specific or individual products.
- Specific ID — Tracks individual items of inventory with a serial number or RFID tag, but not too many manufacturers have items identified like this. It works better with high-value items that need differentiation than it does for interchangeable items.
An accountant can help you figure out an inventory plan to ensure you have enough raw materials on hand without breaking the bank to stock them. You can find cloud-based platforms to manage inventory, but then you’ll have data stored on your own servers and some elsewhere. If one element of the systems is down, you lose your accounting flow chain.
But the positives of cloud-based solutions include being able to access your data via the internet. Your accountant will be able to view your accounts with you in real time and be able to explain the implications of indirect taxes to address, such as managing use tax accruals on inventory movements, for example.
You may buy items into inventory without knowing how or where those things will be used. If you have a tax accrual process in place, you’ll minimize audit exposure. Automating procure-to-pay processes could prevent tax overpayments and save money.
While U.S. manufacturers don’t pay sales tax on raw materials used in a final product, you may be responsible for indirect taxes on purchases of equipment and supplies like machines, conveyor belts and forklifts.
The challenge is to know whether the goods or equipment you’re purchasing will be used in a manufacturing or R&D process, which is usually tax exempt or reduced rated. These taxes can be very complex to track and manage; the burden is on the manufacturer. In some states, manufacturers get credits for R&D, other states have exemptions for manufacturing equipment. You need to know which regulations apply to your operations.
Even slight errors in purchasing can have a big financial impact. Inventory management helps optimize how you use inventory and provides alerts when stock needs replenishing. You don’t want to have too much or not enough inventory to fulfill your customers’ requirements.
Lean manufacturing is all about minimizing waste while maximizing productivity. The extra complexity of calculating inventory can be assuaged with software that extracts data and analyzes trends. Let us help you choose the best one for your manufacturing business.