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Simple Inventory Control

Author: Larry Chester, President

The Income Statement certainly gets most business owners’ attention. The connection between your company’s operations and the balance sheet is just as important. Remember, the Balance Sheet shows the value of your business at a point in time. Here it’s not an overall picture that tells the tale, it’s the amount in each individual account that shows the difference between a growing, thriving business, and one that has lost control over its major assets.

Bringing Value Through CFO Insights

Two accounts on the Balance Sheet that hold large value for many companies are Inventory and Accounts Receivable. But it’s not just the size of these accounts that’s important, it’s the measure of control that is exerted on the underlying operations in those areas. Every business owner knows that these are important. If they don’t apply solid business practices to controlling and managing those areas, the resulting business risk results in additional cost to the company.

  • Business – Manufacturer of consumer products for big boxes
  • Location – West side of Chicago
  • Sales – $32.5 million
  • Ownership – Single owner (60%) and ESOP (40%)

Initial contact –

After selling a significant portion of the company to an ESOP, the long-time owner suddenly had someone looking over his shoulder – the ESOP Trustees. Issues that never concerned him before were brought to the surface, since they affected company value. Bank reporting included a monthly borrowing base, in which Inventory and Accounts Receivable played a significant role in credit line availability. So, increased interest was focused on those two topics.

Significant Findings and Recommendations:

Inventory Control

The company had over $5 million in inventory and had never done an annual physical count. When their bank finally required a physical as part of their borrowing base reporting, a 10% variance was uncovered. That $500,000 hit to the bottom line needed to be corrected to assure that it was never going to happen again. Controls on inventory movement needed to be put in place, and a program of mutual responsibility among the warehouse staff needed to be instituted. Accurate inventory had to be everyone’s goal.

Recommendations

  • Fix the cause, not the symptom. Verification of inventory isn’t an end in itself. There needs to be a commitment to find the root cause of the problem. Losses discovered in the counts are the symptom of an operational problem. Each time missing product is discovered, there needs to be a commitment to uncover the reason the inventory is missing. Then procedures need to be changed to keep it from happening again.
  • Cycle Counting is more efficient. Yearend physical inventories are the norm in many companies, but they take a lot of time and staff. Some companies literally close their operations for several days to perform that once a year physical. But, how do you discover the cause of the problem that’s been a year in the making? Dividing the inventory into A B and C categories based on value or movement provides a basis for weekly cycle counts. This allows inventory to be verified multiple times a year, providing an opportunity to correct procedural problems. Result – cycle counts took 1.5 hours each week for two people. Time spent – 156 hours annually, less than half the time spent on an annual count. Annual physicals were eliminated. Plus, there was no break in company operations during the counts.
  • Provide incentives for warehouse workers. Although a physical with a 10% variance is daunting, provide a free lunch for the entire company each time there’s a perfect cycle count. Providing a lunch for each person in the company creates a team reward for warehouse accuracy. When everyone is rewarded, then everyone is concerned that their little part is done perfectly. Result – variances dropped to less than 0.02% on the weekly cycle counts, and a free lunch was provided every 4 to 6 weeks, when they hit those perfect counts.
  • Verify master pack quantities. If the UOM (unit of measure) is wrong in the computer system, then the quantities shipped can be a multiple of the quantities you expected to ship. A systematic review of the UOM for every product will verify that the stocking unit is the same as the shipping unit.
  • Provide for a double check at the dock. Have someone double check each skid for the proper quantities before it gets loaded on the truck. If errors are found, then they can be easily corrected before leaving the dock. This eliminates not only inventory control issues, but customer problems as well.

Accounts Receivable Chargebacks

Increasingly, it seems that large retailers find new ways of making the lives of their suppliers difficult. Unusually detailed shipping restrictions, hard to meet packaging considerations, specific instructions on timely shipments. Some of these may be necessary for smooth stock operations at the receiving dock. But often, it seems to be just another way of building revenue on the back of the supplier. Care needs to be taken with each shipment to assure compliance. In the accounting department, chargebacks need to be carefully handled to minimize lost profits.

Recommendations

  • Create a logbook for chargebacks. It’s important to track the reasons for the chargebacks. This way chargebacks that keep recurring are identified and can be corrected. Result – the logbook identified individuals that needed retraining to eliminate packing and labeling errors. Chargebacks were reduced by 60%.
  • Follow-up on the chargeback. Some accounting people don’t want to take the time to research the chargeback and may just stick it in a drawer to be “dealt with later.” A response to the chargeback in 48 hours will send a message to the supplier that this is a concern to you. Result – the pushback resulted in a reduction of chargebacks for miscellaneous problems by over 75%. Was this the result of our work to train staff or refusal to accept charges from the customer? Unsure, but the reduction was noteworthy.
  • Look for small open amounts in the AR Aging. If a customer pays an invoice except for some small dollar differences, it might be because of a fine or penalty. Identifying those items, and not just writing them off, can identify some issues in the Accounts Receivable department.

Company profitability is best set on a solid foundation and built brick by brick. Each error, whether it be in Inventory Control or in Accounts Receivable, eats at profitability one small bite at a time. When they are left uncorrected, net income is reduced on a daily and weekly basis. As time passes, more errors and problems get added to the top of the pile. Finally, it’s impossible to see any of those little, inconsequential errors that have reduced the profits of the company so dramatically.

It’s more than good procedures that help maintain profitability. The work of each individual is key to the success of any company. Employee engagement, which is necessary to fixing any problem in any company, is dependent on their feeling that they are part of the solution. Without that, they are just part of the problem. Consider the many things listed in this newsletter. How many of them would make a difference in your company? Little changes add up to big results.

 

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