Managing Value, Part 3: Inventory Control

The function of every business is to transform raw materials into finished goods thereby adding value that customers are interested in paying to acquire. The transformation process is the obvious function to identify value added to the product. The question I am discussing in this blog is; can each function be managed in such a way as to contribute value to the final product? This week I am thinking and writing about the Inventory Management function. So how does a company manage inventory to maximize product value?

Inventory Control

The actual financial value of inventory on a company’s Profit & Loss, Balance Sheet and taxes can be significant. An accountant will tell you that since the cost of goods sold = (beginning inventory) + (inventory purchases) – (ending inventory) the value of inventory has a direct impact on profitability. An accountant will also tell you there are three ways to compute the value of inventory. FIFO, first-in-first-out, means your cost of sales is based on the items purchased earliest. LIFO, last-in-first-out, means your cost of sales is computed using the items purchased latest. Finally WAC, weighted average cost, means that your cost of sales is figured using the average cost of the items purchased during the corresponding time period that the sales occurred. Understanding this is important but what does managing inventory to add value mean operationally?

Strategically I want high quality inventory for the best purchase price I can get, for the cheapest delivery cost possible. I want to store it for the shortest time possible and handle it as little as possible. Just-In-Time inventory management caught on for a reason. Since cost, quantity, quality and timeliness are king I need material handlers that know this and care about the details of the job. In receiving every delivery needs to be counted and inspected so that quantity and quality variances can be documented and reported. Quantity variances need to be reported to purchasing so actions can be taken to make sure production shortages do not happen. Poor quality items need to be quarantined, inspected and labeled for return authorization. Many companies change the purchase prices on their Purchase Orders to match the prices on the receiving document or the vendor bill by doing this they lose valuable price variance information. I want to know what my vendors said they were going to send, at what cost and compare that to what they actually sent and actually charged. If I track the differences I have valuable vendor performance information.

Some companies use a pull method which involves production or material handlers “pulling” inventory from the warehouse as it is need at each workstation. Other companies use a push method which means inventory handlers “push” inventory to the workstation ahead of time based on the planned production schedule. Either method can work but what adds value is what saves the most time for both material handlers and production workers. Strategically this means a highly organized warehouse with specific storage locations for specific inventory, positioned as close to where it is needed in production as possible. Material handling adds cost and the less time spent doing it adds value to the product.

For many companies the biggest issues related to inventory management revolve around exceptions. Every movement or transfer of inventory should be documented and reported as soon as possible. If inventory gets damaged while being handled or during production does it get recorded right away or at all? Do finished items get reported as complete even if they are “short” or missing a critical piece that will get added later? What if the completed short never gets reported? How long does the finished item wait to be completed or even worse what happens if it gets delivered to the end customer incomplete? Does customer service or warranty ever take inventory from production to satisfy a customer claim but does not report the use of inventory. All of these “non-standard” uses or movement of inventory can stop production due to material shortage and financially the cost of inventory will be misstated. It seems like there are many ways to strategically manage inventory to add value to the product and the key word is manage.

< Back to Blog Home