November 1997 • Volume 7 • Number 11
The Success of Systems
and Inventory Issues
|
|
November 1997 • Volume 7 • Number 11 The Success of Systems |
|
|
Dear APICS: How successful are companies at
implementing manufacturing systems? Most of us have probably heard success or failure rates mentioned in a presentation, or seen them in articles. When chasing these down it is common to find that they are opinions based on someone's experience, but not based on systematic assessment. Failure rate figures I have seen include 80 percent and 99.7 percent [both cited in Meredith, 1981, pg. 12]. These are figures which turn out to be opinions when examined in the original sources. So what is a reasonable answer? I believe a reasonable answer concerning how well companies implement manufacturing systems is one that portrays a spectrum of outcomes — some companies do it very well and reap the potential benefits; some do it very poorly and reap only the increased costs; and most are partially successful, eventually recovering their investment but not realizing the system's full potential. The Oliver Wight Companies have published survey results several times which indicate a range of outcomes. These include MRP II and JIT system implementations. Various kinds of success measures are reported, including inventory reduction, improved customer service, increased productivity, reduced purchase cost, costs vs. benefits, ROI, reduced manufacturing cost, reduced lead times, space reduction, better control of the business, increased market share, better vendor performance, improved quality of life, and reduced end-of-month crunch. It is clear that companies which implement well gain important benefits and competitive advantages. A detailed study by White, et al.(1982) of over 400 companies implementing MRP systems identified several factors which distinguished between successful and unsuccessful implementers, or were noted as major problem sources during implementation. The key factors were: current data accuracy (especially inventory records, market forecasts and capacity plan); computerization; lack of support from top management/marketing management; lack of support from foreman; lack of company expertise; and constraints from computer hardware. The answer to your question is not a simple percentage. It involves a range of results over several kinds of performance measures which are affected by several starting conditions and implementation factors. I recommend being highly suspicious of simple answers which lack substantive support. References
Dear APICS: Recently, I heard a representative of
a major consulting firm say that a $100,000 reduction in
inventory would result in a $1 million increase in operating
profit. Can this be (true)?
You get my drift. Operating costs go up in such circumstances (while operating profits go down) because inventory was reduced in an unwise manner. However, I would expect a well-executed move into lean production to produce both a significant inventory reduction and an improved operating profit. If the starting conditions were quintessential U.S. manufacturing of the past, it may be possible to achieve that 10:1 ratio that sounds so intriguing. But it would not be a simple case of cause and effect. You couldn't just pull out X amount of inventory and expect that action to cause a ten-X increase in operating income. All the homework that establishes the enabling conditions for lean production, from smart product and process design, to total quality, to reduced setups and lot sizes, to preventive maintenance, to stabilized schedules, to pull systems of execution, to simplified accounting such as backflushing, to linked/improved supply chains, etc., creates the following results: smooth, just-in-time flows, requiring minimal resource investment (including inventory) and involving relatively little overhead expense. These in turn correlate with vastly improved operating profit. If you'd like to see some well-founded numbers which support my belief, take a look at Figure 4.7 in the book, "The Machine That Changed The World" (James Womack, et al., Harper-Perennial, 1991). This worldwide study of automobile assembly plants cites startling statistics on lean vs. mass production operations. They also point out how much "opportunity" may exist for improvements. Dear APICS: How can we convince our auditor to
eliminate the requirement for an annual physical count of
the inventory? I have great personal experience with annual physical inventory counts and can empathize with this statement. For example, big annual counts are often performed by people who are temporarily shifted from their normal duties or hired from outside. They are likely to be unfamiliar with the items and/or the storage locations. This can lead to all sorts of "noise" getting into the record system, resulting from errors of misidentification, miscounts, missed locations, etc. The exercise may ultimately result in an acceptable financial outcome. However, offsetting errors, financially, can constitute multiple operational errors. This is because identically priced As and Bs probably will not substitute for one another in use. On the other hand, a physical count does force WIP inventory which has been sitting around back into inventory, and may trigger cancellation of unneeded work orders. Let's walk in the other functions' shoes for a few minutes and seek some understanding of the auditor's viewpoint. It may help you to prepare a convincing case to eliminate the annual exercise. Swartley and Hall describe a five-step inventory audit plan which typically consists of "proving that the inventory (1) exists, (2) is completely represented, (3) belongs to the firm, (4) is properly valued, and (5) is properly classified. To develop the inventory audit plan, an auditor must verify a firm's system of internal controls in addition to verifying management's financial assertions by obtaining evidence about them" (pg. 22). These, then, are the auditor's concerns. To address them, an inventory audit plan is created based on "three principles: (1) adequate inventory controls, (2) factual assertions about inventory records, and (3) evidence to prove the existence of the controls and inventory transactions" (pg. 20). To establish that inventory included on the balance sheet physically exists, the auditor observes the physical inventory and obtains confirmation of inventory at other locations outside the firm. To assure that inventory quantities represent or include all products, materials and supplies on hand, the auditor observes physical inventory counts and compares the balances with recent purchasing, production and sales activities. Examination of paid vendors' invoices and contracts establish ownership of the items counted. To ascertain if inventories are valued properly and "that slow-moving, excess, defective and obsolete items are properly identified, the auditor once again examines paid vendors' invoices and contracts, reviews direct labor rates, examines inventory turnover rates, and reviews industry trends"(pg. 20). Finally, draft versions of financial statements are reviewed to verify that inventories in the balance sheet are classified correctly as current assets. This assures accurate presentation and disclosure in the statements. The auditor examines the firm's inventory controls which are in place to safeguard company assets (in an accounting sense, inventory is supposed to be an asset; JIT enthusiasts might claim it is a liability) and to assure that accounting records are accurate and reliable. A good system of inventory controls assures that "proper procedures and documents are in place for: removing inventory from the storeroom (material requisition form), ordering inventory (purchase requisition form and the purchase order form), receiving the inventory (receiving report), physical security and control of inventory, and disbursement of funds for the inventory"(pg. 21). The authors explain five assertions about inventory that firms generally make when preparing financial statements. "They are � that its inventory exists at a given date and that transactions occur during a given period. � that all inventory transactions and accounts are complete, i.e., included in the financial statements of the firm. � that it has rights to the inventory and that any liabilities are its obligations. � that inventories are included in the financial statements and at the appropriate amounts (valuation and allocation). Finally, a firm states that the inventory's classification and description � its presentation/disclosure of the inventory is accurate" (pg. 21). Accounting records, like journals and ledgers, are evidence of an accounting process but are insufficient to "competently support the financial statements a firm makes about its inventory"(pg. 21). Relevant accounting records must be corroborated by interviews, calculations, physical observation and inspection of inventory, and by review of transactions and related documents pertaining to inventory. Now that we have stood in the other function's shoes it will be easier to understand the specific concerns that must be addressed in order to justify cessation of the annual physical inventory audit. It all boils down to having a robust system of inventory control, probably including an effective cycle counting program with root cause error removal, that achieves the conditions auditors need to sign off on a firm's assertions about its inventory. It has been done. There are firms which no longer are required to shut down the plant and perform a complete, annual physical count and reconciliation. Armed with an understanding of the above, sit down with your auditor and find out what they will accept as evidence of a robust system and accurate inventory information without doing the annual physical count (which is a non-value-added activity that attempts to inspect quality into the records). Suggested further reading: Swartley, J.; Hall, J., "Inventory Auditing: A Manufacturing Perspective," Production and Inventory Management Journal, Vol. 29, No. 4, Fourth Quarter 1988, pp. 20-22. |
