Mind your Work In Process – and MINE FOR GOLD
I was watching a news program the other evening and saw an interesting story about retirees panning for gold. Seems that when the market took it’s down turn, and with fixed income returns being so low, this has become a popular pastime to supplement their retirement income. They spend the day in the stream, searching for the elusive small nuggets, and sell them at record high prices. “It’s really hard work, I’m dead tired at the end of the day, but it pays off when you find an ounce or two” stated one Senior gold miner.
A few days later, I was speaking to a friend of mine. He is a controller for a manufacturing company, and was in the middle of costing out his year end physical inventory. Between raw materials, work in process and finished goods, he was close to “that point”. That’s when your eyes blur, you struggle to focus, and you feel like you could lie down on the floor and get a good 4 hours of sleep with everyone stepping over you to get to the coffee pot. He commented to me “This yearend inventory sure is hard work, but it is really worth it. We get to find ourmistakes for the year, good and bad”
My first thought was, funny how hard work always seems to pay off. Then, I started thinking about the yearend inventory fallacy. Find your mistakes for the year the following January? Who can afford to wait that long? There are gold nuggets that can be turned into cash in your inventory all year long. The first step is to get your company on some hybrid of cycle counting. You find nuggets early in the game by plugging these cash flow leaks. And, you can address inventory control mistakes, and possible theft, when there is still time to fix it.
But, quantity counts are only part of the problem when it comes to inventory losses. The area I like to focus on when evaluating a company’s inventory processes and procedures is in the element of Work In Process (WIP). That’s where I like to pan for inventory gold.
It doesn’t matter if you are in manufacturing, construction, food processing, assembly, health care, etc. If you are taking a purchased item (raw material, components, and pieces parts) and adding value with labor through a one or multiple step process, you will have WIP to be concerned with. The problem with WIP is that it has inherent issues that lead to a cash drain on your company, typically without raising the red flags until after the fact. And if you wait until the end of the year to find out your problems, the money is already gone. With proper best practices, it could have been saved along the way.
Here’s the issue: materials, labor, and other expenses flow into WIP. Typically, companies have sufficient inventory procedures set up to track the raw materials before they enter the process and the finished goods that flow out of WIP at the end of the process. It’s during the process (WIP) that they lack the procedures, and the will, to track what is happening. As it flows through WIP, control is lost on standard quantities, hours, packaging, components, etc. How many times have we heard “its half done, have to finish it now”, or “can’t leave it half built” or “if I add this material or that component that’s not on the bill of material, I can save the run”. Not that there is anything wrong with that, Kramer. But, to run efficiently and effectively, the business needs to know that it is costing more and recognize those costs on the correct run, batch, product line, etc. Also, it needs to expense the extra cost in the appropriate period, which may be when produced or when sold. Certainly not at the end of the fiscal year. And, the longer the time these products spend in WIP, the more costly it becomes to recover the investment and the more likely there will be multiple problems before it ends up as a salable product.
What causes these issues? Here are some areas to evaluate that can help mitigate your losses in WIP.
Bills of Material: Are they accurate? When they are not, do you have a system in place to make the approved changes? Is everyone (estimating, Sales, Operations, Costing, Inventory control) made aware of the fact that changes are needed, and who is accountable to approve and make those changes?
Scrap / spillage factors: Face it; they are a fact of life. Make sure your bill of materials has an accurate factor to cover them
Scrap Reporting: If scrap isn’t reported and the defective items fixed or replaced with more products and labor, those costs “disappear”. Accurate scrap reporting is essential to controlling your costs.
Rework Costs: Once Operations agrees to add these costs, track them separately and evaluate for future decision making
Track your costs through the WIP process: Track your costs, on a monthly basis, through WIP. At minimum, the costs should be tracked in total by cost element (Material, Labor, Other, And Overhead). Preferably, your software should track WIP costs by element and by identifier (work order, batch, building, job, etc.)
Bonuses: Here is a big one. Pay your bonuses on profitability (preferable at the smallest possible identifier, i.e. job), not on productivity.
For many industries, Work In Process is a part of life. In fact, it is during this process that a company adds its value and profit to the end product. It can also have devastating affects to your profitability and cash flow when not controlled. When you mind what happens in your WIP, you are MINING GOLD NUGGETS! It’s hard work, but it sure pays off when you find them.