How to Avoid Year-End Surprises
© 2007 Door & Access Systems
Publish Date: Spring 2007
Author: Bruce McConnell
How to Avoid Year-End Surprises
The Benefits of a Monthly Inventory Adjustment
By Bruce McConnell
In late January or early February, many door dealers complete the dreaded year-end physical inventory tabulation. Yes, it’s a hassle, but it’s financially essential to take a physical inventory at least once a year. It offers several benefits.
The value of your inventory gets booked. Your gross margin is brought into a more accurate range. You verify the true cost of goods consumed by your business. You make sure you have everything on hand that you think you do. And you get your first glance at how you really did the previous year.
If you don’t do a regular physical count, you are forced to rely on your paperwork and/or your bookkeeping system to maintain a “perpetual” book inventory. This time-consuming and difficult process is one that many small businesses choose to avoid.
Preventing the Year-End Surprise
An annual inventory is just good business. But a quick monthly count of your high-dollar and biggest movers is also a good idea, because it will help to minimize any surprises at year-end.
Although maintaining an accurate monthly count is possible, many door dealers lack the systems, manpower, or knowledge to keep it up to date. Let’s face it, a monthly inventory takes a lot of time, and nobody really wants to do it. Even if you use a bookkeeping system, you’ll find that many of them still require a diligent effort to maintain an accurate inventory on a monthly basis.
At the end of 2006, some of you may have seen your gross margins fall well below levels you saw earlier in the year. Many of my clients have grown tired of this year-end surprise and have developed some methods to prevent it. One key tactic they use is to track the change in their Inventory so that its impact on cost of goods sold (COGS) is reflected more accurately every month.
No Inventory—Low Accuracy
One client of mine in Oklahoma was getting frustrated with his new bookkeeping system because it was not giving him the accurate gross margin each month. Because he chose to avoid the inventory module, the materials reflected in his cost of goods were only the reflection of the products that he purchased that month.
Rather than seeing the effects of his consistent pricing, which should show a fairly stable gross margin rate, his margins would swing dramatically from month to month. It would sometimes swing from 25 to 50 percent and back down again to 30 percent. The accuracy and reliability of his monthly profit and loss statement was minimal at best.
Create a System
To remedy this problem, I recommend that you establish a system for monitoring the approximate value of the goods that are still on hand or “in process” at the end of each month. Assuming that your base inventory remains the same, the change between this and the previous month’s amount becomes your Inventory adjustment.
There are many ways to quantify your monthly inventory adjustment. You can review your monthly purchased material invoices or the material used in that month’s job costing detail, or use the more complicated work-in-process tabulation.
The simplest method involves comparing the monthly material invoices to the amount of goods still on hand for jobs in your backlog. Remember that this adjustment is intended to represent the approximate change to your inventory value, too.
Once you make your adjustment, the gross profit should be fairly representative of the amount generated by the jobs completed and invoiced that month. Because all months are not created equal, remember that any significant change in sales mix between months should move the gross profit rate up and down accordingly.
Example: Before and After
My Oklahoma client started using his open work orders to make the estimated monthly adjustment to his COGS and inventory. The tables below illustrate the difference between his before and after reports.
The inventory adjustment was based on the amount of materials already received for jobs that had not been invoiced to the customer, minus the amount of materials taken out of the beginning inventory to support invoiced jobs. This includes materials in the warehouse, on the truck, and at the job site.
In the example tables below, the invoiced value of these materials was already included in the COGS when the bill from the vendor was entered.
The lesson: Calculating and booking a monthly inventory adjustment can help you gain a much better picture—and better control—of the profitability of your company throughout the year.
Bruce McConnell, a financial consultant (815-288-3556, firstname.lastname@example.org), has been helping door and access systems dealers since 1992.