How to Make Inventory Easier on Your Business

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Dear CFO,

As the controller in a very small manufacturing company, taking inventory is the worst job in the world (ok, maybe not the worst, but certainly tedious). The process itself is hard, but the reconciliations are even more difficult. My team uses information provided by the shop floor and sometimes I’m not sure if they really counted. What can I do to make inventory easier?

Inventory Not Managed in New England

You aren’t alone in your frustrations. New ERP (enterprise resource planning) systems can make inventory easier with real-time tracking. But keep in mind, these ERP systems are still dependent on good information. You know the old saying – garbage in/garbage out?

During inventory, many of the inputs are usually completed on the floor and not under your direct control, presenting another problem. Senior management must be involved in improving the inventory process. This takes us back to a discussion of policies and procedures. When there are clear policies and procedures with assigned responsibility, there are fewer errors and much less finger-pointing.

How to Make Inventory Easier

At the heart of it, an effective inventory process comes down to effective management. The discussion points below may seem so obvious and rudimentary that you can’t imagine they create problems, but you’d be surprised. So, let’s go through the tasks and resources included in a successful inventory procedure.

Timely and Accurate Recording in the Inventory System

  • Implement a policy stating who can order inventory and how much inventory they can order at a time. The policy should cover the types of materials and the dollar amount each team member has the authority to use when they purchase. If larger amounts of materials, inventory, or supplies are needed, who is responsible for the escalation? Sophisticated systems control spending policies with set dollar limits based on login authority.
  • Record part numbers for all inventoried items, typically called the Item Master. There should be a policy covering who can set up the numbers on new parts in the system, along with the numbering method and a procedure to record it consistently. Properly identify all the characteristics for each part in the inventory system. Characteristics in inventory systems include:
    • costing for purchase and pricing for sale,
    • units of measure for purchase and use/sale,
    • accounts for transactions,
    • descriptions for purchase and sale,
    • various other information related to vendors, serial numbers, bills of material, etc.
  • Place purchase orders through the control system. This assures the recording of inventory orders happens under proper authority. Management can easily see open orders that might influence production or cash flow planning. (This is different than costing methods, which is another discussion.)
  • Receive inventory by recording through the system and against purchase orders, simultaneously implementing procedures to resolve short shipments or other issues. This enables accounts payable to process quickly knowing there is authority to pay for the amount ordered and at the price indicated. Make sure all inventory received prior to month-end (or inventory date, if different) has the appropriate invoices processed.
  • Use a bill of materials. If your company makes a product repetitively, whether it’s an assembly, manufactured, or you’re running a construction company, identifying the parts used to make it and recording the bill of materials will automatically relieve inventory. In sophisticated systems, the recording is done as the part is processed. In other systems, a manual input may be required to “complete” the recording. Inventory procedures make clear who, what, where, and when to assure consistency.
  • Record all shipments of finished product through the system along with the related billing.

Physical Space Needed for Inventory

  • Control high-value items in a secure place to avoid tempting employees to “walk” off with them. For example, when copper is expensive, the copper wire should be locked in a cage. Not all team members should have access to all inventory.
  • Place high-volume items in an easy to reach space, neatly organized. Clearly label inventory locations. Clearly label all parts. This might require a number, description, or barcode. This inventory organization may also require bins, shelves, buckets, and other receptacles. Neatly organize lower volume and bulky items as well. Limit access to the inventory but ensure if someone is looking for a part, they’re able to find the RIGHT part.
  • If using a Kanban or other inventory staging type of process, allocate adequate space for the inventory staging. A corollary is to limit the amount of inventory movement. (I once had a client who lost a full order during production because someone didn’t put it in the right spot. Several months later, they found it.) Over-capacity is also an issue.
  • Segregate obsolete inventory and overstock inventory. Record your obsolete inventory and preferably sell it off. As an auditor, I once identified that based on current usage the client had 300+ years of a certain part. Don’t make this same inventory mistake! If you have consigned inventory, it should also be segregated.
  • Keep the workspace and production areas clear (I realize this is often a more involved process and there is a need to address the various means of getting inventory to where it is needed). Cell manufacturing looks different from production lines and assembly lines.
  • Use min/max capabilities of the inventory system to avoid keeping too much inventory on hand – an expensive proposition.

Implement Proper Cut-Off and Inventory Procedures

  • Pay attention to work in progress. If you have product that doesn’t complete in the measured timeframe, you must identify how much of the process is complete and properly attribute raw materials not yet relieved from inventory.
  • Measure all processes at the same point. Inventory received has an invoice recorded. Manufactured parts bills of material are processed. Shipments bill in the same timeframe as they are shipped.
  • Develop specific inventory procedures for your organization. This sample inventory procedure uses a pre-printed inventory sheet system and may be more complex than your company requires. Often pre-numbered inventory control tags are used.

Make Inventory Easier by Avoiding Garbage In/Garbage Out

If the policies and procedures defined above aren’t followed, taking the physical inventory, identifying and quantifying the differences becomes extremely time-consuming. That’s not to mention the possibility of generating larger book/physical adjustments. Common inventory problems include:

  • Items ordered in different units of measure than used and a system that doesn’t properly reflect the difference. For example, batteries are purchased by the box containing 4 and used individually. So, receiving 1 box isn’t the same as using 1 battery. Most systems will automatically record the conversion if the item master is set up correctly.
  • Variances in inventoried amounts. In less automated systems or where inventory is taken to a job site and the team members report the usage, it’s imperative that the released amount is compared to the used amount. Management must investigate significant variances, as well as make sure the inventory usage is recorded in the same period as it is actually used.
  • Shrink and theft due to poor oversight. Losses are inevitable without physical control of appealing (high-value, readily marketable, or useable) inventory that can “walk” away.
  • Poor inventory setup. Inventory setup is critical to maintaining the proper dollar account balance associated with the items in the physical inventory list. Make sure the pricing of the physical items is done using the same methodology as the general ledger account. If your dollars move in on a FIFO basis and the inventory list prices at average cost, there will be differences.
  • Inventory system settings that are changed too easily. The ease with which smaller accounting systems are changed is a double-edged sword. Setting security settings (somewhat limited in smaller systems) and turning on the audit trail will make it easier to trace who and when a number is changed.
  • Employee burnout. Physical inventories are tedious for everyone involved and as a result, may meet with resentment. Make inventory easier for everyone. Consider using a cycle counting process to count high value or high-volume items more frequently and lower value/volume less frequently. This does depend on systems in place that assure the completeness and accuracy of the inventory accounting. A cycle counting process is a win/win for all involved: if the activity is recorded timely and accurately, there is less work with the physical inventory.

While I have clients who still take a “full” physical every month, most businesses with proper policies, procedures, and oversight are able to limit the process. Inventory is a big job but there are certainly ways to make the inventory count easier for all involved. I hope your team leaders are willing to work with you to get policies and procedures in place as well as encourage compliance.

Featured image by SparkFun Electronics; post images licensed for use via Flickr CC 2.0 and Pxhere Public Domain.

About Author

about author

Lynne Robinson

Lynne brings years of experience in service industries, manufacturing, leasing and corporate finance. She started CEO Buddy to help small business owners grow their businesses.

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