May 25, 2016
Proper controls over inventory are vital to any business as inventory is often the largest asset on a company’s balance sheet. Couple this with the fact that inventory is directly tied to cash management and profitability, and you begin to understand why establishing proper controls over inventory is imperative. Vital inventory controls include safeguarding inventory, maintaining proper stock levels, managing purchasing, establishing proper costing systems, aging of inventory and quality control.
If inventory was the largest asset on your books, wouldn’t you want to ensure there were safeguards set up to protect it? As you build inventory stock, you will need to warehouse the goods somewhere. You may also have employees involved in the manufacturing, handling and storage of the goods. Business owners should ensure that warehouses that house their goods have proper security measures in place. For example, an alarm system should be in place and access to the warehouse should be limited to authorized personnel. Even with physical security measures, business owners still run the risk of warehouse personnel theft. To that end, background checks should be performed for all employees or only bonded personnel should be used. Safeguarding inventory should also include environmental controls. If you have perishable goods or goods that are sensitive to environmental elements, then business owners should ensure that backup systems are in place to prevent goods from spoilage or damage in case primary systems fail, as in the case of a power failure or a similar event.
Properly managing inventory stock levels is also a very important inventory control. If you have too little inventory, then you cannot fulfill customer orders and risk losing sales. Conversely, if you have too much inventory, then you run the risk of goods becoming stale and/or obsolete, as well as potentially incurring unnecessary storage charges. To find the proper balance, controls should be in place to accurately determine the optimal amount of goods to have on hand. There are many accounting and inventory management software programs on the market to assist with this. These programs account for movement of goods and maintain a perpetual inventory. However, a system of performing periodic physical counts should also be established. This involves physically counting goods on hand at a specific point in time and then comparing the counts to the perpetual records. Variances between physical counts and perpetual records should be analyzed on a regular basis to ensure that the inventory in the system is accurate.
Depending on your business, you may want to consider purchasing goods based specifically on customer orders instead of stock-piling goods. This works in situations when your customers can make purchases and wait for the goods to be delivered. If customers cannot wait for their goods and you need to maintain a certain level of stock, then developing a forecast model is a good practice.
If your customer base and demand is fairly static and the seasonality of the business can be reasonably predicted, then you can manage purchasing of goods in an attempt to prevent over or under stocking of inventory.
Since inventory is directly tied to the profitability of a business, business owners should make it a point to ensure they have a system in place to properly account for the cost of inventory. Again, there are many inventory management software programs on the market to assist with this. With reliable costing systems in place, an important control is to ensure costs are properly matched with sales. This allows the business owner to perform gross profit analysis by significant product line on a regular basis.
A drop in the gross profit percentage often signals the business owner that it’s time to raise prices or seek alternate suppliers.
An issue that often surfaces as the result of not having proper controls over maintaining proper stock levels and managing purchasing is old inventory. The purpose of analyzing inventory aging is to focus on inventory in stock that is starting to get old. Inventory that is not turning costs business owners money and takes up warehouse space.
For this reason, it is a good practice to work in a process to liquidate aged inventory first. This may include selling at a discount, boosting sales commissions on older inventory or donating the inventory.
Finally, effective quality control is also a significant inventory control. Can a business withstand the damage a poor quality product does to its reputation? Again, the proper software program is one of the best things business owners can do to improve inventory operations. The proper software can help the company keep the right resources on hand to produce high quality products. In addition, physical inspection and testing of goods should be performed on a regular basis. For example, if producing mass quantities of goods, a few of these goods should be removed from the line and tested to determine if required predetermined specifications are met.