One of the greatest wastes of cash is poor inventory management.
And one of the greatest surprises at the end of your fiscal year when you take inventory is to have
a great loss. This means that your cost of goods was lot higher than your thought it was
and that you didn't make as much profit as your financial statements said all year. You
may have lulled yourself into a comfortable feeling of making good profits when you were actually not
accounting for all of the materials that you used...this is a false sense of security.
Your employees rarely think about the consequences of leaving inventory on the job,
damaging it or forgetting to write it on a service ticket. I've found parts, filters,
materials, etc. left on jobs, in dumpsters, and damaged in trucks because no one took the time to
care for his or her inventory. Your employees' normal reaction is "no big deal, the boss
can afford it" unless you educate them on the impact of their actions with inventory usage.
Over the next few issues I'll write about some inventory management ideas that
can help you conserve cash. Implementing these ideas will give you the sense of security
knowing that what is on your financial statements with respect to material usage and inventory is
correct so that you don't have a surprise at the end of the fiscal year.
How do you get surprised? First, by not properly accounting for
inventory on your financial statements each month. Many contractors' financial statements
that I see have the exact same inventory figure each month. I know that this isn't correct
because your inventory rises and falls each time you purchase something for the trucks, a preseason
stocking order, etc.
The current assets segment of your balance sheets states your inventory value.
Assume that number says that you have $20,000 in inventory in your business.
When you count inventory at the end of the year, you only count $10,000. This means
that you have used $10,000 more in materials than you thought you did. So, your
expenses increase by $10,000 which means that your profit decreases by $10,000 and the net worth of
your company decreases by $10,000. It means that your gross profit was lower than you
previously thought.
Here are some true stories. A contractor I worked with counted
inventory at the end of the year. He had a $30,000 deduction to his financial statement.
This contractor generated a little over $1,000,000 per year. $30,000 is a
significant portion of his profits that evaporated the day we finished counting the inventory.
Is this possible? Easily.
Many years ago I worked with a contractor who had not counted inventory for
about two years. When they finally took inventory (after much prodding on my part) we
found that the inventory that the financials statement said was tehre was about $250,000 more than
what they actually counted. The impact was that the company was worth about a quarter
of a million dollars less the day that inventory was taken...the lost $250,000 of net worth.
You say, "This can't happen to me." It is actually very easy to have
this happen. If you divide the $250,000 into two years, that is $125,000 per year or $2,500
per week (assume 50 weeks). There were about 30 different crews or service technicians
who handled inventory. This means $83 per week or $17 per day. Leave a box of
flex on the job, damage and few grills, leave off a part used on the job, etc.
Now that I've got your attention, here are some specific activites to make sure
that you don't lose a quarter of a million dollars of net worth in a day:
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If your haven't counted (and I mean really count!!) your inventory in the
past, make the commitment to do so at the end of your fiscal year or sooner. I
promise that the first time you take it is the most difficult. After you get the
systems set up, it becomes easier and faster to count it and value it. Many companies shut
down for a morning or an afternoon or a day to count inventory. Everyone counts and everyone
calculates the value of inventory. Technicians are paired. Each technician counts
the truck of his partner while the user of the truck records the information. Using this
system, you can get inventory counted in an afternoon or a day. It lessens the agony!
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Decide what is inventory and what is shop materials. I don't
expect you to count sheet metal screws in partially opened boxes. Make a list of all of
the pieces that you will not inventory but simply expense to shop materials. Make sure that
you are adding a $3 to $5 charge on each service ticket to cover the shop materials cost.
A partial list of what I consider shop materials for a service department includes: sheet metal screws,
duct tape, wire nuts, oil, hand cleaner, rags, electrical tape, and caulk. Some of these items are
inventory items for installation departments so you have to be careful when you determine what is
inventory and what is shop supplies.
The reason that I consider these shop materials rather than
inventory is that if you add them to inventory it is very difficult to account for their use.
In fact, it costs more to account for their use than their real value is. So, to make it easy,
don't inventory these items and immediately expense them to shop materials when you order, for example, a
case of duct tape. Make sure that the revenues you get from shop materials on service tickets at
least cover all of the shop materials costs. If not, raise your shop materials charge on your
service tickets.
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Track your inventory by looking in two areas of your financial statements.
Looking at these ratios assumes that you have counted inventory and are adding and
relieving inventory each month. The first place to look is the ratio between current
ratio and acid test. If your current ratio is 2, your acid test should be one or better.
In other words, the acid test should be more than half of the current ratio.
If it isn't, then you probably have too much of your cash tied up in inventory. This
ratio is no good if the inventory value on your balance sheet doesn't change each month...or ever.
The second area to look at is your inventory days. If your inventory days are
excessive (over 60 days), then you probably have too much cash tied up in inventory.
If your ratios are in line you want to keep them in line. Make sure that you aren't
counting obsolete inventory. This consists of parts, equipment, etc. that have been
sitting in your warehouse for two to three years or more...and you probably will never use them.
If you want to keep obsolete inventory, fine (there are a few pack rats among us).
Put whatever you can't bear to part with in a special place in your warehouse just in
case that customer calls two years from now and needs that special motor. Otherwise,
have a garage sale and get rid of it.
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Have a standard inventory on your trucks. Your installation crews
should have some inventory so that they don't come running back to the shop or go to a supply house
for a roll of duct tape. Your service technicians can have standard inventory too.
Residential, commercial, and maintenance technicians will have different truck inventories...however the
inventory should be standardized for each type of work you do. Service technicians hate
standard inventory. They will complain about it but once they get used to it you'll save a lot
of time and money.
Contact Ruth King via e-mail at rking@hvacrnews.com.
This article is reprinted with permission from the October 2004 issue of HVACR News.
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