Taking Back Control of Your Inventory Costs

Inventory is typically one of a manufacturer’s top three investments, making it a central factor in the business’ success. Too much inventory wastes capital; too little inventory delays production. It’s no surprise then that many manufacturing enterprise resource planning (ERP) users state that the first and most straightforward value they derive is gaining control of inventory costs and availability.

Let’s look at common inventory management challenges and how they can be addressed using a manufacturing ERP system.

Common Inventory Challenges

At the highest level, inventory is generally considered either raw materials e.g., materials in stock awaiting conversion into finished goods, or finished goods that are in stock awaiting shipment to customers. Inventory issues typically fall into several categories:

• Unnecessarily large raw materials inventory
• Insufficient raw materials inventory to support production
• Raw material inventory that is missing, obsolete, or no longer of value
• Excessive finished goods inventory
• Shortage of finished goods to meet customer demand
• Finished goods inventory that is misplaced or no longer in demand

The root cause of almost all inventory issues is inaccurate planning or a lack of visibility into actual inventory levels.

It sounds overly simplified to say, but inventory control starts with anticipated final goods demand. If anticipated demand flows all the way to shipment without any changes, hiccups, or disruptions, then all is well. But if order levels change, production problems create interferences, or customers change specifications, then inventory starts to drift into shortage or excess mode. Unfortunately, this occurs all too often.

Dealing with disruption is part of the value equation mid-market manufacturers bring to the table, particularly those that are part of a larger supply chain. They make it appear smooth both at the top of the funnel (commit to ship) and at the bottom of the funnel (on-time shipment) and manage all the complexities in between.

Key ERP Tools for Managing Inventory Costs

A comprehensive ERP system uses seven key tools to automate the tracking and control of inventory availability and costs:

• Bill of Materials (BOM) – This is essential to know how much material is necessary to create a finished good.
• Sales Orders – Sales orders start the inventory control process by referencing the BOM to create material demands in the material resource planning (MRP) functions of the ERP system.
• Material Resource Planning – MRP looks at demand created by sales orders and either verifies (and reserves) quantity-on-hand or creates purchase orders to secure the necessary raw materials.
• Production Monitoring – This tracks the actual consumption of raw materials during production and records the creation of finished goods. Both data points are “back-flushed” or updated to the ERP system’s raw and finished goods records, effectively monitoring inventory levels in real t
• Inventory Control – As the system of record for both raw and finished goods, inventory control tracks quantity-on-hand, committed quantities, and quantities-on-order.
• Physical Inventory – The ERP system uses this process to compare actual quantities on hand to the record of the puts and takes as recorded by the inventory control system. Physical inventory ensures that material consumption and replenishment have all been properly recorded by the receiving, production, and shipping operations.
• Forecasting – Many customers rely on their suppliers to anticipate their needs and be ready with products even though they have not yet issued a purchase order. This can be true of both manufacturers who feed into complex supply chains and those that create a finished good that flows into a wholesale or retail sales channel. Forecasting uses historical consumption to predict and time future demands and plan accordingly.

When discussing manufacturing ERP software, the concept of end-to-end visibility and control is often mentioned. The seven ERP processes discussed above, when operating in complete orchestration with each other, is an excellent example of how end-to-end visibility and control can deliver incredible cost savings to a manufacturing operation.

How ERP Can Help Control Your Inventory Costs: 5 Real-World Examples

Now let’s review five real-world scenarios that show how the features of a manufacturing ERP system work in concert to help manufacturers save money by gaining visibility and control over their inventory.

1. Insufficient Raw Materials. A manufacturer’s inventory records show that 10,000 units of particular raw material are on hand. Sales orders and forecasting in the ERP system predict that this material will be consumed in six weeks, and due to supply constraints, replenishment lead times are currently at five weeks. To avoid material shortages next month, replenish purchase orders need to be issued now.  Inventory management works with sales order management and forecasting to prevent finished good shortages valued at $50,000.
2. Deadstock. Inventory records indicate that the manufacturer has 1,000 units of a $90 each finished goods item on hand. Sales history in the ERP system shows that there has been zero demand for the product for the last 24 months. The ERP finance module is notified that $90,000 of finished goods are overstated in assets and must be adjusted in order to honor inventory financing covenants. Inventory management works in conjunction with sales history and finance to avoid a bank covenant default, saving the company $10,000 in inventory financing penalties.
3. Defective Equipment. Production monitoring reports that a defective tool on the shop floor is consuming 40% more raw materials than called for in the BOM. Production must continue to meet the shipment dates, but the MRP module shows there will be a raw material shortage prior to the next production run. Purchasing is notified to execute immediate replenishment of the material due to unforeseen consumption. Production monitoring works together with material resource planning to avoid future production bottlenecks and save $30,000 in idle production capacity.
4. Missing Finished Goods. Inventory records specify that 5,000 units of a finished good are on hand. However, physical inventory cycle counting reveals that only 3,000 units are actually available. The gap is explained by transaction records indicating that 2,000 units were shipped but not recorded by warehousing operations in the prior month. Now, forecasting predicts near-term demand of 4,000 units. With this information, the manufacturer can initiate expedited production and correct the inventory, customer, and billing records. Physical inventory works with the finance module to discover operator error, preventing both inventory shrinkage and future goods shortage, and the $20,000 operator error is corrected.
5. Excess Raw Materials. Raw materials inventory shows that 20,000 units of a component on hand have been stockpiled due to supply shortages. The MRP module now indicates lead times have dropped to normal levels. Meanwhile, the forecasting module shows that the quantity on hand is sufficient for one full year of production. Purchasing is notified that precautionary overstocking of the component is no longer necessary. Inventory management working in conjunction with the MRP and forecasting modules prevents further buildup of excess raw materials, saving $15,000 in unnecessary inventory accumulation.

Conclusion

As one of a manufacturing business’s top three investments, inventory obliviously plays a vital role as the very fundamental means of production. Shortages of inventory can shut a manufacturer down and quickly lead to dramatic financial consequences. At the same time, excess, spoiled, or lost inventory is a direct hit to the bottom line, that, if carefully managed, can be almost entirely avoided.

The combined functionality of an end-to-end manufacturing ERP system provides control and visibility of inventory at a fraction of the cost it would take to achieve the same result using manual inventory control processes.