Behind the Metrics: Inventory

This set of blogs will take you behind some of the metrics you should be measuring in your business. We’ll talk about what they are, what they really mean and more.

We know what you’re thinking … of course it’s important to track inventory. And you’re right, it absolutely is. But it’s more than just the physical finished product in your warehouse you need to track. Inventory has several layers and they’re all important to your business.inventory

Let’s start at the beginning.

Inventory, at its most basic, is your goods on hand. We don’t just mean finished goods either.

Typically there are three components under your inventory account:

  • Raw materials (read, the things you’re using to create your product)
  • Work in progress (the product that’s almost there, but not quite)
  • Finished goods (we’re not going to explain this one)

These are all consider part of your business’ assets.

Seems pretty straight forward.

Well, not quite. Inventory might be a pretty straightforward concept, but tracking it isn’t. In fact, it can get pretty complex. Let’s take a look at the basics…

Raw materials are the basic components that go into producing your product. When raw materials are purchased you debit Raw Materials Inventory and credit Accounts Payable (or another payment type).

Once your product goes to production, you need to start adding in costs such as labor, supplies, occupancy and equipment. These costs can be broken into two (2) categories: direct and indirect.

Direct costs are costs that are easily identifiable to one (1) unit. For example, let’s say it takes a line worker two hours to assemble a unit [and line workers track their time to a specific unit]. The line worker makes $30 per hour. Therefore, you would add $60 to the cost of the unit.

Indirect costs are costs related to the production process however are not easily identifiable to one (1) unit. For example, as a part of the assembly process, the line worker must glue a component to the unit. You wouldn’t necessarily want to measure the glue each time; so you allocate a cost for the glue. You know that one (1) gallon of glue costs $20 and you expect to be able to complete 10 units for every gallon; so you allocate $2 to each unit for the cost of glue.

The direct and indirect costs are added to the raw materials throughout the production process. Here’s what the accounting could look like (actual accounting may differ based on specific circumstances … but this should give you the idea).

 

Account Debit Credit
Work in Progress $XXX
Raw Materials $XXX
Labor Allocation* $XXX
Supplies Allocation* $XXX

*Assuming when you pay the line worker and purchased the supplies, you recorded it to a wages and supplies expense, respectively under costs of goods sold.

Once the production of the unit is complete, you would debit Finished Goods Inventory and credit Work in Progress.

So what can your inventory tell you?

Other than the value of the asset you are holding, inventory can have a direct correlation to how they’re doing (we are talking profitability and cash flow).

What do we mean? Well if you’re holding on to too much inventory and not selling it, you’re basically a costly storage facility. Plus, if you use anything that could spoil, you’ve lost money. Not to mention, your inventory costs money to produce which is recouped when you sell the units; that can lead a cash shortfall if not managed properly. If you have too little inventory, on the other hand, you run the risk of not being able to complete sales in a timely fashion. Which might led to your customers going elsewhere to get the product.

So what do you do? Use an inventory management system. Oh, and a little thing like benchmarking against your peers will also help.

What else do I need to know?

Here are a few common metrics to be looking at within inventory.

Inventory Turnover

In simplest form, this is how often your inventory is sold and then replaced over a period of time. For instance, you can use this metric to see how many times you sell through your inventory in one year. One of the best things to do is then compare this to industry averages to gauge where you stand.

Here’s how you calculate it:

Cost of Sales

Average Inventory

Low turnover could indicate an excessive amount of inventory, as well as low sales. A high ratio, on the other hand, could indicate strong sales. Or it could indicate a large discount.

In essence, inventory turnover is about speed. But inventory turnover is also tied directly to profit. Why? Well, it doesn’t matter how fast you sell inventory if you’re not making a profit each time.

Days Sales of Inventory

Taking your inventory turnover one more step, this is a measurement of how many days it takes you turn your inventory into sales.

Here’s how you calculate it:

365

Inventory Turnover

The inventory to sales ratio is also the first part in a larger ratio, known as the cash conversion cycle. This cycle tracks how long it takes you as a business to convert your resources into cash flow.

Inventory Days of Supply

Days of supply takes your current sales levels and then tracks how many days your current inventory will last. As you can guess, this is an important metric because if you’re low, you’ll risk running out of inventory and not being able to fulfill sales.

The moral of the story …

Inventory management is important and has a direct effect on your business. So ensure you’re not only tracking your inventory, but also looking at it in relation to the sales cycle.

 

 

 

Taxes: Plan Ahead & Don’t Be Surprised

For many of you, the last quarter of the fiscal year-end is here. Have you talked to, or at least scheduled a meeting with, your tax professional yet?

If you haven’t, we recommend starting the conversation. What’s the point? If you expect to have taxable income, now is the perfect time to project what your taxable income might look like; giving yourself time to take action or prepare for the cash outlay to pay Uncle Sam.

Your tax professional can help you strategize legitimate ways to minimize your tax burden or help you avoid surprises on tax day.

Maybe you are a cash basis taxpayer and you can accelerate (or hold off – because it’s important to think about future tax years too!) paying your vendors.

 Maybe you are in the position to purchase fixed assets and take advantage of accelerated depreciation methods. Or again, maybe your strategy will be different based on expectations for future tax years.

 Maybe you have related party balances (we are talking transactions that aren’t at an arms-length … owner balances, related entity balances, etc.). Uncle Sam has special rules for those and you don’t want to be surprised.

 Maybe you are considering your retirement savings, deadlines for retirement plans often correlate to tax deadlines. Not sure about retirement savings options? Click here.

Whatever your situation, if you are expecting taxable income, consider talking to your tax professional. Don’t have one yet? We have hundreds of tax professionals who rock (and have access to national resources which is pretty awesome)!

Kickstarter and Its Tax Implications

Need funding to get your idea off the ground? Turning your idea into a Kickstarter project just might be the ticket to getting the funding you need. Just don’t forget about the tax implications of using a fundraising platform such as Kickstarter.

Income Tax

Generally speaking, the funds received through a fundraising platform are reportable as revenue for income tax purposes. That makes sense, right? You’re getting money and most money is taxable.

Sales + Use Tax

If you’re thinking about offering a gift for a contribution (maybe it is the product you are trying to fund), you might create a sales or use tax obligation.

Can’t remember what the difference between sales and use tax is? Click here to find out.

While sales tax typically applies to the sale of goods or select services, use tax typically applies to gifts. So if you’re offering a gift, you may need to pay use tax to the appropriate state. The use tax is generally calculated based on the cost to produce the product, not the retail price.

What’s with typically and generally? Remember, your responsibility to remit sales and use tax depends on whether or not you have created nexus. Doesn’t ring a bell? Click here to find out more.

Let’s take a look at an example. Suppose you live in North Dakota and are doing a Kickstarter project for a new granola bar. Individuals contributing $50 to your project will receive five granola bars, because you’re nice like that. You will be selling the granola bars for $4/bar (retail), however, they cost you $2 to produce. When you gift the granola bars (meaning you take them out of your inventory at $2/bar), you are on the hook to pay use tax to the State of North Dakota in the amount of $2 times the applicable use tax rate.

What if the individual contributing is in Iowa? North Dakota tax still applies.

The Bottom Line

Taxes aren’t easy. If you are thinking about starting a Kickstarter project (or another similar fundraising platform), consider speaking to your tax professionals before you start your project. And remember, you might need both an income tax expert and state and local tax (SALT) expert in your corner. If you don’t have them, we’ve got them and they love this stuff.

 

 

How Accountability Can Help Your Organization Succeed

You have a lot of great ideas, but nothing’s really getting accomplished. Or, you’re trying to move things along on a project, only to find out no one really knows who’s in charge of the project.

Welcome to the need for one of the most important aspects of a successful business. ACCOUNTABILITY.

Why you may ask?

Accountability provides the roadmap to get things done.

When there is accountability in an organization, the employees know what is expected of them and what they can expect from the organization. Not only does accountability help foster a positive work environment, it also helps increase the overall performance of the business. Who doesn’t want that?

So how can you create accountability in your business? Here are a few tips:

  1. Have clearly defined roles and responsibilities. Do your employees know their place on the bus? Do your employees know what their overall responsibilities are? How about their day-to-day expectations? Do your employees know what their critical success factors are?Critical Success Factors – what an employee needs to accomplish to succeed and help the business succeed.
  2. Give your employees a sense ownership. Do your employees feel that they are a part of something bigger; that their performance matters to the business as a whole? Do they feel they have control over the measurements they’re being evaluated on?
  3. Build a trusting team environment. Do your employees feel they are able to give and receive feedback without ramifications? Do your employees feel they are able to seek information from other team members?
  4. Give your employees the resources and knowledge to make decisions. Are your employees empowered to make day-to-day decisions regarding tasks? Do they have the freedom to make those decisions?
  5. Don’t make it about punishment– rather, make it about improvement. When your employees fall short, are you the first to point it out and yell? Do you provide constructive feedback about ways to improve or hit the mark next time? Are there incentives for a job well done? If your employees fear failure, you will lose qualities like innovation.
  6. Make sure you have a performance evaluation in place. Do your employees know what they are doing well? How about areas of improvement? Do they know the value they bring to your business? Feedback (constructive, of course) in the workplace is invaluable. In addition, it’s a good idea to have multiple forms of feedback to ensure a fair evaluation. Sources of feedback can be from customers, key metrics, supervisors, peers, and/or subordinates. The feedback can be in the form of surveys, dashboards, roundtable discussions, etc.

In summary, accountability is one of those characteristics a truly successful business needs. It provides traction to achieve your goals and vision. If no one is accountable for the success of your business (other than you), it will be hard to steer the bus in the direction you envision it going. Need help? We have the resources to help you create accountability in your business.