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Specialized Inventory Is A Problem

Author: Larry Chester, President

Inventory is an asset on your balance sheet. Finished goods can be converted to cash relatively easily. Raw materials end up becoming finished goods, thereby completing that part of the cash cycle. But excess raw materials may be difficult to dispose of if no longer needed. Not only that, but raw materials need to be available in the proper proportions or the money invested just sits there, waiting on the shelf.

Bringing Value Through CFO Insights

Not all manufacturing uses stock materials. Sometimes specialized raw materials are purchased to produce product for one individual customer. Even though this is common practice for some companies, it can create additional risk for the manufacturer, because it can only be used for one customer, one product. As long as the delivery follows in due course, it’s not a problem. But it can become a major issue if things change. Then, who is left holding the bag?

  • Business – Manufacturer of restaurant seating
  • Location – Western Illinois
  • Sales – $30,250,000
  • Ownership – Single Owner

Initial Contact –

The bank insisted that the company get some help. They were bumping up against the top of their credit line constantly. Their inventory control was manual and therefore questionable. Plus, specialized inventory raised questions on their borrowing base. They had been profitable until recently, but their record keeping was inconsistent. The bank had already determined they would not allow an over-advance of the company’s line of credit, and the company had to get expenditures approved daily.

Significant Findings and Recommendations:

Inventory Management

Because the company produces custom seating for franchises, particular components could only be used for that individual brand. As a result, significant inventory just sits, waiting for the next order. The company maintains a manual inventory system, which is updated monthly by full inventory counts. The concern about running out of components results in more inventory on the floor than is needed.


  • Minimize the purchase of specialized inventory. The bank has difficulty loaning on it because it has limited value in a distressed sale. Custom items should only be ordered when Sales Orders are received.
  • Work out arrangements with customers to “pre-purchase” the custom raw materials. This reduces the liability in case of an order cancellation.
  • If pre-purchasing is not acceptable, arrange for a “guarantee” that would require the customer to purchase the raw inventory in the event of an order cancellation.
  • Establish a perpetual inventory system, so that potential shortages can be identified and filled. This also reduces inventory adjustments at month-end.
  • Review Bills of Materials for accuracy. This allows for the standardization of hardware components, reducing the variety of items in the warehouse.

Cash Flow Modeling and Management

Because of lackluster company performance over the past two years, the bank has tightened borrowing availability. As a result, the company supplies daily information to the bank to release payments.


  • Build a short-term sales and operating forecast for the company. Concentrate on realistic expectations for shipments and cash collections.
  • Using the completed operating forecast, develop a 13-week cash flow forecast so that the company can plan for payments and payroll.
  • Track the impact of inventory shifts and shipments daily, so the impact on the company’s upcoming weekly borrowing base certificate is understood.
  • Limit all discretionary spending.
  • Contact all suppliers and negotiate longer payment terms. Then importantly, stick to agreed payment schedules.

Manufacturing and Financial Reporting

The company’s ERP system is only partially utilized. They receive the standard Income Statement, Balance Sheet and Statement of Cash Flows monthly, but there are no subsidiary reports. Those reports would help identify issues for management to address.


  • Develop several dashboards for management and staff to use weekly and monthly, including KPIs on variances in manufacturing, group profitability, returns.
  • Create metrics on labor productivity. Measure actual hours against the proposed setup and production times. Review significant variances, and if needed change pricing or improve operations.
  • The company has significant warranty issues. Identify the root causes of the issues and fix the problems, rather than considering it the normal course of business. Current warranty claims exceed $600,000.
  • Determine the level of reports that are available from the company ERP system, including inventory levels, comparisons to prior years and subsidiary reports detailing manufacturing costs, operating expenses and more. Other items like inventory turns, AR collections (DSO), payroll efficiency should be calculated as part of KPIs.

Any money a company spends should ultimately drive profitability. But when inventory is purchased specifically for an individual customer, cash commitments and risks are increased. Not only are you dependent on sales of your products for your company to survive, but now you’re dependent on a customer to complete their sales order, so you can use the raw materials you purchased for them.

Being able to control your company’s assets is key to your independence. If you are totally dependent on the purchases, sales or payments from any single customer, you are beholden to them more than you may think. This is another aspect of customer concentration. Too often, specialized inventory can become a write-off when the customer goes out of business or makes changes in their business. And, if buying specialized inventory is for a large customer, rather than a general company practice, the risks – especially in an economic downturn – can spell danger for any company.


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