Tighten Your Supply Chain With JIT Purchasing
MARK THOMSON, CPA
Aside from your equipment and property, your most valuable asset is your inventory. But do you find that it is often sitting idle on warehouse shelves or in storage rooms — sometimes for months at a time? As companies have shifted to buying more product from overseas, minimum order quantities have ballooned, helping to create this situation. Do you see inventory reports showing inventory quantities on hand to cover more than 12 months of historical usage? If so, just-in-time (JIT) purchasing may help you reduce its hidden costs.
For distributors, JIT purchasing involves minimizing the lag time between taking possession of your product and shipping it to your customers. While that may seem like a simple concept, JIT purchasing systems require greater collaboration with your customers, suppliers and employees, as well as upfront equipment costs. It also requires employing Lean, Six Sigma, Kan Ban systems or other improvement methods that stress continual efficiency, quality management and operational planning. Today, more than ever, implementing these changes is causing companies to reconsider whether they should continue purchasing inventory from overseas rather than implementing JIT purchasing.
Automation plays a big role in JIT systems. Back-office inventory and ordering software, combined with bar-code scanners and other software tools, is widely available today and can give even the smallest warehouse a leg up on its competition. The latest inventory software and technology provide real-time snapshots of pricing, orders and fulfillment that allow you to minimize waste and over-ordering.
JIT-optimized distributors also typically deal with fewer, but more dedicated, suppliers. In addition, JIT suppliers often enter into long-term contracts with their customers, a win-win for both parties: Distributors can finance crucial components at a guaranteed price, while suppliers get a guaranteed revenue stream. It also means you may be able to convert to a smaller warehouse, do more with fewer employees and invest in less equipment. This is especially important when a company is facing a decision on expanding facilities or moving to larger structures, which means a major capital investment and operational challenges.
But JIT “pull” inventory systems aren’t for the faint of heart. While there are increased profits to be had, a supply disruption or other unanticipated event can send a costly ripple effect up and down your supply chain. To prevent such a scenario, some distributors opt for a hybrid approach that incorporates JIT principles for certain customers and products, but not for others. Maintaining safety stocks may still make sense on key components with especially long delivery times or that are key to keeping a production line operating. As with any approach in today’s ever-changing economy, management needs to consider both JIT purchasing and traditional methods of efficiency and their risks along with the ability of your company to meet its customers’ demand for shorter and shorter lead times for orders.
If you have concerns or questions about JIT purchasing, please contact Mark Thomson at [email protected] or 312.670.7444 to discuss your specific situation.
Stepping Up Your Budget Process
JOEL HERMAN, CPA
How does your company treat its annual budgeting process? Whereas some companies simply take the previous year’s budget and update the numbers based on the past year’s actual spending, the next year’s expected available funds and minor revisions to the company’s goals and business plan, other companies start fresh. They take on the mindset of creating a war plan with numerical battle lines in which their business will fight to succeed in the coming year.
Either approach works fine, but by taking the latter, you’re more likely to have an emotional investment in your annual budget and work harder to achieve your company’s goals.
More Than Just Numbers
Budgets should incorporate all of the business plans, action steps, brainstorming ideas and marketing goals management discussed throughout the previous year. Once you create your budget, it is important to keep it in mind as the year progresses and rework it as new or changing information becomes available. To do so, however, you must augment the numbers with words and descriptions. For example, in an introductory section detail the current state of your business, its market, the economy, and the number and nature of your competitors. Explain how your budget supports your company’s mission, values and specific objectives.
Some businesses get quite analytical when it comes to their budgets. They add line-item details for every allocation of funds, including explanations for, say, why staffing funds are set at a certain level and why equipment needs are funded as stated. You might also add supporting indices, such as summaries and analyses of previous years’ budgets. An executive summary can help users of your budget digest the data more easily, as other users of the budget may not dig into the detail quite as thoroughly as the financial person preparing the budget.
Essentially, your budget shouldn’t consist only of numbers and formulas. It needs to spell out your strategic goals and business plans, and it should depict the competitive environment in which you’re operating.
3 Budget Components
The broader picture surrounding your budget is important, but so are the particulars. So, once your budget is set, keep an eye on a variety of items in light of current circumstances. Generally, a business budget will have three primary components:
- Balance Sheet
This section summarizes your company’s assets, liabilities and net equity. The balance sheet is a snapshot of the financial condition of your business at a particular point in time. Analyze it when you set your budget — it will help you focus on the financial well-being of your company and whether your budget can remain realistic.
For example, if the debt load indicated on your balance sheet is growing at a greater rate than you anticipated, it may be time to make some moves. Cutting discretionary expenses, such as bonuses and travel costs, could get the numbers back in line. You might also pursue refinancing some or all of the debt.
- Cash Flow Statement. This document denotes your company’s cash inflows from ongoing operations and external financing and investment sources, as well as its cash outflows for business activities, financing and investments. It is a critical part of any budget, because strong cash flow is essential to the success of any companies’ day-to-day operations.
It is important to note that cash flow does not always correlate to profitability. A growing, profitable company can have weak cash flow when its revenue is tied up in receivables or reinvested in inventory needs. When reviewing your cash flow statement and the year ahead, think carefully about financing needs during these periods. In addition, consider the need for fixed asset purchases — both planned and unplanned. Many businesses fall prey to cash shortfalls because cash flow is not keeping up with the ability to fund day-to-day working capital needs or acquire new equipment.
- Income Statement
This section typically addresses sales, margins, operating expenses and profits or losses. While the balance sheet is a snapshot of your financial position at a given point time, the income statement is a motion picture summarizing your profitability over a cumulative period of time. As the year progresses, be sure to watch out for profit margin fluctuations and operating expense variances.
If your volume falls off, even by a little bit, it could trigger major profitability problems. When you look at this section of your budget, assess whether 2014 should be a growth or “hold steady” year — or a balance of the two.
The Tax Angle
Like many companies, you may maintain a certain amount of cash to cover income taxes obligations for interim periods. During this time, your budget may seem to be in better shape than it really is because you have not paid out these funds and are overestimating available cash.
Of course, your tax liability will depend on, among other variables, how much sales and resulting net income you generate. So if you find your company is having a better-than-expected year, be careful. Your cash flow might benefit from all that business, but your resulting tax bill could be higher too, which could lead to an unexpected spending variance when you pay Uncle Sam. Proper planning throughout the year and communication with your CPA helps alleviate any surprises.
A Path Toward a Better Budget
Whichever approach you and your management team take to create a budget, it is smart to review it and the overall environment midyear and make any necessary adjustments. Doing so can help your chances of achieving your financial goals as well as creating a better budget next year.