How Inventory Mistakes Affect Your Manufacturing Company’s Financial Results
For most manufacturers, inventory issues don’t usually start as inventory issues. They’re typically created before inventory is ever even received; and many times, they can be traced back to a few (avoidable) mistakes.
These are the most common places where we see inventory decisions go wrong, how they affect your financial results, and (most importantly) how to avoid them.
Early Purchasing Ties Up Cash Longer Than Expected
One of the most common inventory issues we see occurs when purchasing is based on a forecast or a general sense of backlog.
It’s true that forecasting inventory over the next few months is essential for charting your needs and to satisfy creditors. But that forecast doesn’t necessarily mean the materials need to be purchased immediately.
When those purchases happen too early, you end up carrying that inventory before it’s needed. The cash has already gone out, and the inventory is just sitting there until production catches up.
It’s important to remember that carrying that inventory is not free. If it’s being funded through a line of credit, that balance stays higher and interest continues to build while the materials aren’t being used.
Instead of purchasing materials early, tie your purchasing behavior to when those materials are actually going into production. That requires knowing what’s being built now versus what’s sitting in the backlog for later, so orders line up with timing instead of just projections.
Scheduling Production Based on Inaccurate Inventory Data Delays Revenue and Increases Cost
Production gets scheduled based on the materials that your system shows are on hand. But, sometimes, once a job starts, the required material isn’t there after all.
At that point, labor is still on the clock, but the work stops. The order doesn’t ship, so the cash tied to that job is delayed. In some cases, the material has to be rushed in order to finish the job at a higher cost.
To avoid this, schedule production based on inventory that is actually available, and keep inventory tracked closely enough that your system reflects what’s actually on the floor when the job is released. (Cycle counting is a good way to keep those counts current without shutting down production.)
When your counts stay current, your production schedule is based on something real, instead of just what the system says. And if you’re scheduling based on numbers you can trust, jobs move when they’re supposed to.
Letting LIFO Sit in the Background Changes How Your Income Is Read
LIFO has been a popular topic of conversation over the last few years because of inflation, and it’s putting pressure on income statements.
The increase in the LIFO reserve is driving this pressure. That increase flows through as an expense, but it’s a non-cash item. There’s no cash going out tied to that line, even though it’s reducing reported income.
Most of the time, that LIFO adjustment sits in the footnotes, not on the face of the financials. If no one is calling it out, it’s easy for that lower income number to be taken at face value.
That can turn into a big deal in conversations with lenders, in covenant calculations, and even in quality of earnings work. We’ve seen companies go back to their bank and have LIFO adjustments backed out of covenant calculations once it’s clearly explained. The same thing happens in transactions where buyers separate that impact from actual performance. Some companies are also presenting it as a supplemental schedule to make it more visible.
The point is to make sure it’s clear what’s happening, so the financials reflect how the business is actually performing, not just what a tax method is doing to it.
Learn More About Making Strong Financial Decisions for Your Manufacturing Company
Avoiding these mistakes comes down to how those decisions are made in day-to-day operations. None of this is overly complicated, but it does require attention in the right places. And that small bit of attention now to what may feel like minor adjustments can prevent a much bigger problem from arising later.
To learn more, contact your Warren Averett advisor directly, or ask a member of our specialized Manufacturing & Distribution team to reach out to you.
