When your inventory comes up short, it’s easy to turn the missing stash into a whodunit. Are employees freeloading behind your back? Is a light-fingered bookkeeper ringing up fictitious purchases and pocketing the difference?
For manufacturers, though, employee theft isn’t the only potential problem. Complex production processes and the sheer volume of products and materials in your warehouse can make it hard to get a handle on your inventory. That can result inventory shrinkage, where the actual number of items on your shelves is lower than the number of recorded items. In the manufacturing world, shrinkage can also refer to the loss of raw materials, such as metal or food ingredients, during the production process.
Regardless of what you’re missing or how it went astray, even small amounts of inventory shrinkage have a big effect on your bottom line. For example, if you lose $100 worth of products and your business operates on a 10 percent profit margin, you’d need to sell an extra $1,000 worth of items to make up for the loss. That’s why it’s critical to pinpoint the causes behind shortages and take the necessary steps to get your inventory management back on track.
Alternate causes for shortages
One major inventory shrinkage culprit for manufacturers is incorrectly estimating the amount of material used in production. For example, a furniture manufacturer may think it can paint 100 chairs with one vat of paint, but in reality, it painted 95 with the last vat and 110 with the one before that. Without historical data on its material usage, the manufacturer has no way to gauge accuracy, leading the company to think it should have 12 vats of paint on its shelves when there are really only 10.
Data and human errors can also wreak havoc on inventory accuracy. Receiving errors, such as selecting the wrong barcode or entering the wrong quantity, are easy to make but hard to catch once the items are in your warehouse. Another common error is picking the wrong unit of measure for shipping, such as a case instead of a unit. The tipoff there is that the discrepancy in the inventory count is a multiple of the unit of measure.
Back office errors, such as duplicate payments to vendors, can also cause discrepancies between what’s on your books and what’s in your warehouse. Unrecorded breakage, damage and errors during physical inventories are other common problems. A thorough review of your books will often turn up the problem. From there, employee training on inventory management practices is essential for making sure everyone is handling inventory and recording transactions appropriately.
When it’s fraud
Sometimes, though, fraud is the only explanation for disappearing items. Inventory theft can be difficult to diagnose in manufacturing companies because of large numbers of items, complicated accounting methods, the number of employees with access to inventory and involved production processes.
Prominent schemes include “fictitious vendor,” where an employee places an order that’s never delivered and steals the payment. Other types of purchasing fraud include inflating demand for an item with the intent to steal the excess inventory. Regular audits of your operational procedures are critical for nipping these schemes in the bud, as is separating duties so that the same person isn’t placing and processing orders.
Shipping fraud schemes, such as marking a shipment as short even though the right number of products arrived, can also result in inventory discrepancies. To combat this, have someone outside of receiving perform inspections and make detailed reports.
To identify inventory fraud, look for a pattern of shrinkage or abnormal shrinkage for a particular location or product. Suspicious bookkeeping entries, such as round figures or credits in the purchases section, can also be a tipoff.
When it comes to your inventory accounting metrics, red flags for fraud include slowing inventory turnover, inventory increasing faster than sales, shipping costs decreasing versus inventory, inventory rising faster than total assets, increasing cost of sales compared with total sales, and a cost of goods sold that doesn’t match the books. Also look for changes to your gross profit margins, or the gross profit divided by sales. An overly high figure might mean overstated inventory; a low figure could mean theft.
Better systems for better results
Whether your vanishing inventory is the result of dishonest employees or subpar recordkeeping, inventory management systems and processes tailored to your business can go a long way toward reducing shrinkage.
Inventory management software options abound, from simple systems based on barcodes to elaborate ones that microchip each item in your warehouse so you know where everything is at all times. Implement a system that works for you and train your employees to use it correctly to cut down on data and processing errors. Minimizing the amount of inventory sitting on your shelves can also help improve accuracy. Many manufacturers use Just-In-Time inventory management practices, where materials are ordered as needed instead of weeks or months in advance.
Adopting an effective cycle counting system, where you count a portion of your inventory daily, can also help you get a better handle on your products. Pay extra attention to high-value items, frequently ordered products, or items with a history of discrepancies. Many manufacturers find that cycle counting eliminates the need for doing physical inventories, which can be time-consuming and delay production.
If fraud is your issue, bulk up your security measures, including cameras and guards, if necessary. Limit the number of entry and exit doors to your warehouses, and review security video daily. Review your books regularly for signs of fraud as well, including checking materials received against vendor invoices and examining inventory adjustment reports. Asking a third party to do cycle counts can also cut down on suspicious activity and provide a hedge against shrinkage.
Your inventory is one of your greatest assets, so treat it with care. By keeping a close eye on your products and tackling issues as soon as they come up, you’ll bolster your bottom line and your company’s success.
