Benefits of Stockpiling Raw Materials Questioned

U.S. manufacturers should avoid the temptation to build up costly stocks of raw materials and component parts, even when such goods are in short supply, warns a major accounting and management consulting firm. According to a national study by Grant Thornton LLP (Chicago, Ill.), 36% of all U.S. manufacturers with annual sales between $10 million and $500 million recently have encountered significant shortages of raw materials or parts, and 20% say they will increase such inventories because they fear future shortages.

Instead of building up stocks of these critical materials, midsize companies should forge stronger working relationships with their suppliers through just-in-time (JIT) schedules and vendor-managed inventory (VMI) programs, says James Krasner, director of logistics services for Grant Thornton LLP. "Whether they make goods for the general consumer or parts for use by other producers, manufacturers are part of a supply chain," said Krasner. "Many large manufacturers, distributors and retailers are requiring their suppliers - and their suppliers' suppliers - to adopt advanced inventory management practices in order to respond to the customer's specific order requirements, often on a few day's notice."

Today's technology-driven inventory processes, such as JIT and VMI, are designed to minimize inventory costs by reducing the need for all companies within the same supply chain to purchase, store and track product that cannot immediately be manufactured or sold, Krasner observed.

There is a cost for nearly every aspect of inventory, beginning with the initial investment in materials. Other factors, such as labor, warehouse space, taxes and insurance, can double a company's financial inventory-carrying costs, he said. Additionally, indirect expenses occur whenever excess inventory creates confusion and bottlenecks in the warehouse or on the shop floor. There is a further risk that product will become damaged or obsolete when a company holds inventory over time.

"But as advanced inventory management techniques are integrated throughout the supply chain, such costs can either be decreased or eliminated along the way," Krasner explained. "Ultimately, these reductions will be reflected in the product's final price. This is one way that all companies within the same supply chain can add value to each other, as well as to the consumer."

According to Krasner, another downside to carrying excess stock is that companies must report the dollar value of inventory on their balance sheets, which reduces earnings ratios. "High inventory costs could be viewed negatively by shareholders, outside investors and lenders," he said.

Manufacturers should not overlook the tax ramifications of maintaining too much inventory. "From a federal tax standpoint, there is no advantage to holding onto excess inventory," he pointed out. "A company cannot write off the value of inventory until it is sold, donated or scrapped. And there are state and local tax implications stemming from where the inventory is located and who owns it. Inventory that supports the same supply-chain needs can be subject to very different state and local rates."

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