Inventory management isn’t just about purchasing new materials. Sometimes it’s also about getting rid of the materials that have become unnecessary.
Here, we discuss the common strategies used to identify inventory that’s past its usefulness for the company and what to do about it.
Conditions That Lead to the Need for Inventory Disposal
Manufacturers typically assess several conditions when deciding to dispose of old stock and materials. These conditions may vary depending on the industry, regulations, and company policies, but some common factors include:
1. Shelf Life
Some goods have a limited shelf life, and manufacturers need to dispose of them before they expire to maintain product quality and safety. This is typically done by managing the age of the part batches. It also should be done visually to make sure that environmental conditions aren’t hastening their lives. Batteries and other parts that contain chemicals, as well as UV or light sensitive materials are good examples of parts that may degrade over time.
2. Obsolescence
Products or materials may become obsolete due to changes in technology, consumer preferences, or regulations. Manufacturers may dispose of old stock that is no longer in demand or compliant with current standards.
3. Damage or Defects
Damaged or defective products may not meet quality standards or be safe for use. Manufacturers should dispose of such items to prevent them from reaching consumers and causing harm or negative brand perception.
4. Excess Inventory
Manufacturers may have excess inventory due to overproduction, changes in demand forecasts, or canceled orders. Disposing of surplus stock helps free up warehouse space and reduces carrying costs.
5. Regulatory Compliance
Manufacturers must comply with regulations regarding the disposal of hazardous materials, electronic waste, or other regulated substances. Failure to adhere to these regulations can result in fines or legal consequences.
6. Cost Considerations
Keeping old stock and materials in inventory incurs storage costs, including rent, utilities, and labor. Manufacturers may weigh the cost of holding onto outdated inventory against the potential benefits of selling or disposing of it.
7. Storage Space Constraints
Limited warehouse space may necessitate the disposal of old stock and materials to make room for new inventory or more profitable products.
Finding What Needs to Go
Manufacturers employ various methods to search through their inventory for materials that need to be disposed of. These methods aim to efficiently identify obsolete, expired, damaged, or excess materials that no longer serve a purpose in the production process. Here are some common approaches:
1. Using Inventory Management Systems
Manufacturers utilize inventory management software systems to track and monitor their inventory in real-time. These systems often include features such as barcode scanning, RFID technology, and batch tracking. These enable manufacturers to quickly identify materials that meet specific disposal criteria, such as expiration dates or damaged status.
2. Regular Physical Inventory Counts
Manufacturers conduct regular physical inventory counts to reconcile the quantities of materials on hand with the quantities recorded in their inventory management systems. During these counts, employees visually inspect materials for signs of damage, expiration, or obsolescence, flagging any items that need to be disposed of.
3. ABC Analysis
ABC analysis categorizes inventory items based on their importance and value to the business. Manufacturers can use this analysis to prioritize their efforts when searching through inventory for disposal candidates. Items classified as “C” or low-value items may be scrutinized more closely for disposal.
4. Expiration Date Tracking
For perishable or time-sensitive materials, manufacturers may implement expiration date tracking systems to ensure that expired items are promptly identified and disposed of before they become unusable. This may involve setting up alerts or reminders in inventory management software to notify staff when materials are nearing their expiration dates.
5. Quality Control Inspections
Manufacturers conduct routine quality control inspections of incoming materials and finished products. During these inspections, materials that fail to meet quality standards may be identified for disposal. Quality control teams play a crucial role in identifying materials that pose quality or safety risks and need to be disposed of accordingly.
6. Supplier Communication
Manufacturers maintain open communication channels with their suppliers to stay informed about any recalls, product changes, or quality issues that may affect the materials they have received. Suppliers may provide notifications about materials that need to be disposed of due to defects or regulatory issues.
7. Demand Forecasting:
Manufacturers use demand forecasting techniques to predict future sales and production needs. By accurately forecasting demand, they can adjust their inventory levels accordingly, reducing the likelihood of excess materials that may need to be disposed of.
Considering Sunk Costs and Future Value
It’s easy to think that all inventory has some intrinsic value to the company regardless of whether there’s an explicit need for the parts. Employees look at the parts and see the price paid or simply think the inventory is worth something and thus, cannot be disposed of. Many times, this is untrue – especially from an accounting perspective.
In corporate finance and accounting, sunk costs are costs that have already been incurred and cannot be completely recovered, regardless of the decision made. Buying parts for manufacturing is essentially ‘sinking’ cost into production materials. Once the company has purchased the parts, that money has been spent.
When deciding whether to dispose of inventory, manufacturers need to focus on future costs and benefits rather than past expenditures. Here’s how manufacturers may approach the consideration of sunk costs in the context of inventory disposal:
Emphasize Attainable Return on Investment
Manufacturers must consider factors such as storage costs, potential salvage value, market demand, and the impact on cash flow and profitability. Sunk costs, which are irrecoverable regardless of the decision, should not factored into these considerations.
Avoid the Sunk Cost Fallacy
Manufacturers strive to avoid falling into the sunk cost fallacy. This occurs when decision-makers continue investing resources in a project or asset because they have already invested a significant amount, even if future benefits are unlikely. Instead, they should focus on maximizing future returns and minimizing future costs, irrespective of past expenditures.
Compare Incremental Costs and Benefits
Manufacturers should assess the value of retaining inventory versus disposing of it. They consider the additional costs incurred by holding onto inventory, such as storage expenses and the opportunity cost of tying up capital in unsold goods, against the potential benefits of selling or scrapping the inventory, such as recovering salvage value or avoiding future obsolescence costs.
Practice Cost-Effectiveness Analysis
Manufacturers typically model potential scenarios to evaluate the financial implications of different disposal options. This involves comparing the total costs and benefits associated with each option, including sunk costs, but giving greater weight to future costs and benefits that can be influenced by the decision.
While manufacturers acknowledge sunk costs as part of their overall financial picture, they should focus primarily on future costs and benefits when deciding whether to dispose of inventory. By considering future implications rather than past expenditures (sunk costs), they can make more rational and economically sound decisions that maximize value for the company.
Adjusting Inventories after Disposal
When disposing of materials, manufacturers need to adjust their inventory values to reflect the removal of these materials from their balance sheets. The specific accounting treatment may vary depending on the accounting method used (e.g., FIFO, LIFO, weighted average) and the nature of the disposal. Here are some common approaches:
1. Write-Offs
If the materials being disposed of have become obsolete, damaged, or expired, the manufacturer may write off the value of these materials as an expense. This reduces the inventory balance on the balance sheet and reflects the loss of value incurred.
2. Net Realizable Value (NRV)
If the materials can still be sold but at a reduced price compared to their original cost, manufacturers may adjust their inventory values to reflect the estimated net realizable value. This adjustment is typically made when the market value of the materials declines below their carrying cost.
3. Scrap Value
When materials are scrapped or recycled, manufacturers may recognize any proceeds from the sale of scrap materials as a reduction in inventory value. The difference between the original cost of the materials and the scrap proceeds is recognized as an expense.
4. Provision for Obsolescence or Loss
Manufacturers may establish provisions or reserves on their balance sheets to account for potential losses from obsolete or slow-moving inventory. When disposing of materials, they may utilize these provisions to offset the reduction in inventory value.
5. Specific Identification
In some cases, manufacturers may use specific identification to track the cost of individual items in their inventory. When disposing of materials, they adjust the inventory value by the specific cost of the items being disposed of.
6. Inventory Write-Downs
If the market value of inventory declines below its carrying cost but is still higher than its net realizable value, manufacturers may write down the inventory value to the lower of cost or market. This adjustment reduces the inventory value on the balance sheet.
7. Impairment Charges
If there is evidence of a permanent decrease in the value of inventory, manufacturers may recognize impairment charges to adjust the inventory value downwards. This is typically done if the carrying amount of inventory exceeds its recoverable amount.
Regardless of the specific method used, adjusting inventory values when disposing of materials ensures that the balance sheet accurately reflects the value of inventory on hand and the impact of inventory write-offs or reductions on the financial statements. These adjustments are crucial for maintaining the accuracy and reliability of financial reporting.
Investing in the Best Tools for the Job
Managing inventory can be a data-heavy process. Once a certain scale is achieved, businesses need to have robust tools to handle all the information needed to make proper decisions. For many small and medium sized manufacturing businesses, it’s found in Material Resource Planning (MRP) systems like Aligni MRP.
Systems like Aligni are built on robust databases that make storing and accessing inventory information easy. It also combines production management aspects and purchasing data and processes to help provide a more cohesive understanding of inventory on-hand, inflows, outflows, and demand requirements. With this information all in one application, managers can make better decisions on what materials needs are and what needs to be disposed of.
Bringing It All Together
Inventory management goes beyond buying and holding. It also involves making sure a company’s stock on-hand is lean and profitability-focused. If it’s to be done properly, managing all these aspects can become process heavy and quite data-intensive. For growing organizations, the investment in inventory management software like Aligni MRP is the best way to bring these processes and data from multiple departments into the same application. This interconnected viewpoint crafted from up-to-date information is key to realizing the best results.
If you’re looking to have greater control over your parts and materials, including better oversight into what needs to be disposed of, sign up for Aligni MRP today!
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