Jim Thompson

Email Jim at jim.thompson@ipulpmedia.com

Innovation in inventories is very dangerous. I can save you the reading of this column by telling you there are no shortcuts to accounting for inventories properly.

I mentioned in the first of this series there are accounting methods that are used for inventories. First in, First out (FIFO) and Last In First Out (LIFO). These are accounting decisions. My good friend, Bill Fuller (ret., Weyerhaeuser) offered up another, FISH (First In, Still Here). Thanks, Bill.

I can think of three kinds of inventory. Raw Materials and Additives. Work in Progress (WIP) which is used to account for products partially finished, such as in a printing plant. And finally, Finished Goods.

You may choose to use modern systems, such as bar codes and air tags to speed the counting of your inventory but NEVER CHEAT ON THE COUNTS.

Time for the old man to tell a story. Two other executives and I were tapped to take over a large but very old facility. On a good day, when we got there, it made 333 short tons or 10,000 short tons per month. Pause for a career note; always run toward problems; this is the quickest way to advance your career when you succeed. If you don't succeed, you are likely one in a long line of people who tried, and you can recover.

Anyway, this pathetic facility was making 10,000 tons per month. When we looked at the books, 8,000 tons were missing! We finally determined they weren't missing but were fictitious. Taking this information to headquarters, no one wanted to hear about it, we were left to our own devices to fix the problem. It took us several months, but we worked it off. Starting the first month, we physically counted the inventory every month.

A physical count is the only way to go.

Now, keeping your inventories, all your inventories, as low as possible is the goal of great management. Why? It keeps your cash requirements low. But this activity does not take place physically near the inventories--it is part of your manufacturing process. Study your processes, all of your processes, and see how you can improve them. Better quality made faster.

At that same old mill I was talking about above, we determined when we got there that a given fiber stayed on site for about three months and we actually did something to it for about an hour! That is a lot of wasted cash flow. You can do better than this.

Be safe and we will talk next week.

For a deeper dive, go here.

Study Guide: Innovation in Inventories

This study guide provides a comprehensive review of the principles and case studies presented in Jim Thompson's analysis of inventory management. It explores the critical nature of accurate accounting, the categorization of inventory, and the strategic relationship between manufacturing processes and cash flow.

Short-Answer Quiz

1. What is the author's primary warning regarding innovation in inventory management? The author asserts that innovation in inventories is inherently dangerous because there are no shortcuts to proper accounting. The text emphasizes that while methods may change, the fundamental requirement for accuracy remains absolute to avoid financial discrepancies.
2. Identify and briefly describe the three accounting methods for inventories mentioned in the text. The three methods mentioned are First In, First Out (FIFO), Last In, First Out (LIFO), and a humorous alternative suggested by Bill Fuller called First In, Still Here (FISH). These represent the accounting decisions used to track the flow and value of materials through a business.
3. What are the three specific categories of inventory defined in the article? Inventory is categorized into Raw Materials and Additives, Work in Progress (WIP), and Finished Goods. Raw Materials are the starting components, WIP accounts for partially finished products like those in a printing plant, and Finished Goods are the final products ready for sale.
4. How should modern technology, such as bar codes and air tags, be utilized in inventory management? According to the text, modern systems like bar codes and air tags should be used specifically to increase the speed of counting inventory. However, the author stresses that these tools must never be used as a means to "cheat" or replace the integrity of the actual counts.
5. What career advice does the author offer regarding difficult professional assignments? The author suggests that professionals should "run toward problems," as successfully resolving difficult situations is the fastest way to advance a career. He notes that even if one does not succeed, they are simply part of a line of people who tried, which allows for professional recovery.
6. Describe the inventory discrepancy discovered at the large, old facility managed by the author. Upon taking over a facility producing 10,000 short tons per month, the management team discovered that 8,000 tons listed on the books were missing. Further investigation revealed that these tons were not physically lost but were entirely fictitious entries in the accounting records.
7. How did the author's team resolve the issue of fictitious inventory once it was identified? Because headquarters was unwilling to address the discrepancy, the team had to "work it off" over several months. This was achieved by implementing a strict regimen of physically counting the inventory every single month to ensure accuracy and transparency.
8. Why is a physical count considered the only reliable method for inventory verification? The author argues that a physical count is the only way to ensure the books reflect reality, as demonstrated by the failure of the "fictitious" accounting at his previous mill. It prevents the accumulation of phantom inventory and forces management to confront actual stock levels.
9. What is the strategic goal of keeping inventory levels as low as possible? The goal of maintaining low inventory is to keep a company's cash requirements low, which is a hallmark of "great management." High inventory levels represent tied-up capital that could otherwise be used more effectively elsewhere in the business.
10. According to the text, how can a company physically reduce its inventory levels? Inventory reduction is not achieved near the storage area but through the manufacturing process itself. Management must study every process to improve quality and speed--making "better quality made faster"--to minimize the time materials spend on-site.

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Quiz Answer Key

1. Innovation Warning: Innovation is dangerous because there are no shortcuts to proper accounting; accuracy is paramount.
2. Accounting Methods: FIFO (First In, First Out), LIFO (Last In, First Out), and FISH (First In, Still Here).
3. Inventory Categories: Raw Materials/Additives, Work in Progress (WIP), and Finished Goods.
4. Role of Technology: Bar codes and air tags are for speed; they must not be used to cheat on counts.
5. Career Advice: Run toward problems to advance quickly; success brings advancement, while failure in a difficult task is recoverable.
6. The Discrepancy: 8,000 out of 10,000 tons of inventory were found to be fictitious (non-existent) on the facility's books.
7. The Resolution: The team "worked off" the fictitious inventory over several months and instituted monthly physical counts.
8. Physical Count Importance: It is the only way to ensure inventory reflects reality and prevents the creation of fictitious data.
9. Management Goal: Keeping inventories low minimizes cash requirements and optimizes cash flow.
10. Reduction Method: Studying and improving manufacturing processes to produce better quality goods faster.

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Essay Questions

1. The Ethics of Inventory Reporting: Analyze the implications of "fictitious" inventory in a corporate setting. Why might a facility engage in this practice, and what are the long-term consequences for management and the organization?
2. Technological Integration vs. Manual Oversight: Discuss the author's perspective on using bar codes and air tags. How can a company balance the speed of modern technology with the author's insistence on the "physical count"?
3. The Relationship Between Process and Profit: Explain the author's argument that inventory management is a function of the manufacturing process rather than a storage issue. Use the example of "fiber staying on site for three months" to support your answer.
4. Risk and Career Advancement: Critique the author's advice to "run toward problems." What are the potential risks and rewards of this strategy in a modern corporate environment?
5. The Impact of Inventory on Cash Flow: Using the concepts of Raw Materials, WIP, and Finished Goods, describe how inefficiencies in any of these stages lead to "wasted cash flow."

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Glossary of Key Terms

* Cash Requirements: The amount of liquid capital a business needs to maintain its operations and inventory levels.

* Fictitious Inventory: Inventory that is recorded on a company's books but does not exist in physical reality.

* FIFO (First In, First Out): An accounting method where the oldest inventory items are recorded as sold first.

* Finished Goods: Completed products that are ready for sale to customers.

* FISH (First In, Still Here): A humorous acronym for stagnant inventory that remains in storage for excessive periods.

* LIFO (Last In, First Out): An accounting method where the most recently produced or purchased items are recorded as sold first.

* Physical Count: The manual process of counting every item of inventory on hand to ensure accounting records are accurate.

* Raw Materials and Additives: The basic materials and supplementary substances used in the primary stages of manufacturing.

* Short Ton: A unit of weight equal to 2,000 pounds.

* Work in Progress (WIP): Inventory that has entered the manufacturing process but is not yet a finished product.

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