Lack of Inventory Control —
Over the past 30 years in construction, there have been countless times when I’d meet a job foreman wandering around the shop or yard muttering, “I know we have it out here somewhere.” He’d look and look for that misplaced tool, a section of steel plate or even a backhoe. “Where did it go? I need it today for my job,” he’d say in frustration.
Being analytical, I always wondered how many costly labor hours were actually spent on such a non-productive and futile search for “Waldo” – that illusive but critical item, hidden in plain sight or actually just gone. Then the foreman would request purchasing to buy whatever item went missing.
Imagine that! Sure you can. You’ve been there. It doesn’t take Albert Einstein to figure out the cost of a lack of inventory control.
Construction companies with large inventories of materials and equipment that may in whole or in part be “consumed” by a job can prove to be both operationally and financially challenging. Static and dynamic inventories are financial assets of the company and they have significant cost implications at the job cost level, particularly on the corporate balance sheet. In addition, there may be significant hidden liabilities.
Static inventories, such as equipment ranging from small tools to cranes and bulldozers, present (or should present) a less complex general accounting and job costing problem. Put simplistically, these mostly static items can be capitalized and depreciated at a relatively predicable unit cost and billed against a job. This may be particularly true for the most obvious items like heavy equipment that is basically being “checked” on to or off of a given jobsite. The estimator and project manager should know, in advance, the unit cost of these static inventory equipment and material items as these are used. The same is true for sheet piling and like reusable materials that are not consumed by the job.
Dynamic equipment and material inventories are treated, from a job costing perspective, in a different manner than are static inventory assets. Generally speaking, static assets in inventory (i.e., a library book) are expected to be returned and retain a certain value as a company asset. Dynamic inventory, like lumber used in concrete forming, steel components or aggregates, are almost always expensed to a job as a singular one-time job cost. These types of inventory items are also company assets until consumed by a job – and billed.
What can significantly throw the inventory ledger out of whack is when there is amassed a significantly large value of a dynamic inventory that was charged to a job, expensed, and then returned for use on a subsequent job or not used at all.
This situation gives rise to a couple of potential issues. First, returned or unused dynamic material inventories that were expensed as a job cost and placed back into inventory may later be included as an asset without an off setting capital cost. This can have the effect of inflating the overall value of the company even if the material itself has little actual value. Second, estimators who rely on the merchantability of the returned asset may overvalue its actual usability or assume a minimal budgeted job cost since these may not appear in the inventory, and, thus, are “invisible.” The affect would be to distort the financial performance of both jobs. Finally, there may be additional depreciation costs against the company bottom line. The bottom line: this type of practice is risky.
A steel fabricator, for example, may order a large quantity of specialty rolled steel columns and beams from a supplier. These are then cut to their needed design length. What remains are scrap called “drops.” While all the beams and columns, as originally ordered, were expensed to the job, the drops were never accounted for and become part of an unseen dynamic inventory. As far as the estimating, accounting and purchasing departments are concerned these drops, which can count as a significant asset, do not exist even though these are actually assets.
Also, I want to touch on the subject of depreciation in terms of inventory control. This usually affects static inventory such as tools and equipment. These are commonly company assets that are purchased, capitalized, placed into inventory and depreciated over a period of time. In practice, when used on a specific job, the depreciation costs are included in the overall rate charged to a job when any specific piece of equipment or static inventory material is used. I call depreciation the “silent killer.”
I say this because depending upon how a company manages its finances, equipment inventories do depreciate in value when these are capitalized. If unused or under used equipment is allowed to accumulate the equity value of the company may be inflated. But then, the depreciating values of these same assets drag down the bottom line and become a significant liability. If you analyze your static inventory and see items that are a drag to the bottom line – consider liquidating them.
The other thing about most static inventory items is that they need maintenance to hold their value in your inventory otherwise they are merely costly depreciating junk. The obvious items are pieces of equipment like trucks or earthmovers that, if left to languish, become large paper weights. But, you may also own smaller items like metal frame forming panel systems. These are expensive to keep in usable condition – the panels wear out, get punctured, and parts get broken or lost. These are just a few examples, but you get the picture. Do not defer, in your job costing or inventory expense, the direct cost of routine maintenance and repair or count deferred costs as profit – it’s not. To do so creates a huge risk, that is, a liability balloon or an inventory valuation equity risk that banks and sureties will certainly discover possibly resulting in a down grade to your credit lines.
From these few examples, and there are literally hundreds, the lack of inventory controls can have a disastrous impact on your company finances. There exist inventory control procedures and costing policies that can be adopted and adapted to avoid this problem.
Here are some practical suggestions to help ensure an effective inventory control program:
- Place someone in responsible charge – an inventory manager.
- Train your inventory manager to serve as a librarian.
- Treat static inventory like a library book; maintain it, check it on and off a job.
- Treat static inventory like it was an internal rental while on a jobsite.
- The internal ‘charge rate’ should include all costs associated with the asset.
- Establish equipment and materials departments like they were a profit centers.
- Track the utilization of static inventory to evaluate return on capital employed.
- Sign out or assign smaller tools and equipment to specific person(s) responsible to avoid inventory shrink. Check their status regularly.
- Sign in, quantify and value returned dynamic inventory.
- Document and communicate the status of all inventories to all other operations departments.