Online Exclusive: Accounting Basics for Small Contractors: How to Control Inventory

July 28, 2014
There are two primary inventory accounting systems: periodic and perpetual. With a perpetual system, sales are recorded as they occur and the inventory balance is updated continuously. Have you noticed fixtures or parts that you used to pick up from a supplier’s inventory are now special-order items? Vendor-managed inventory (VMI) is a process where the vendor (supplier) manages the contractor’s inventory for them.

When I was growing up, I remember my dad asking my mom to save the empty milk cartons. She’d wash them out and set them on the counter in the laundry room. I couldn’t figure out why he wanted empty milk cartons. Then, one day I went out into the garage and saw him cutting off the tops of the milk cartons and putting various plumbing fittings in each of them. I first learned about the different kinds of fittings by helping him. Once they were sorted, I would count how many of each fitting he had in the cartons. It was my dad’s inventory system set up in our garage.           

There are two primary inventory accounting systems: periodic and perpetual. With a periodic system, sales are recorded as they occur but the inventory balance isn’t adjusted each time a sale is made. It’s adjusted at certain intervals or periods of time. That’s what I was essentially doing when I was helping my dad, doing an inventory count. Any adjustments to be made to the inventory account balance are done at the end of the business year.

With a perpetual system, sales are recorded as they occur and the inventory balance is updated continuously (each time a transaction occurs). With significant advancements in technology (hardware and software), the perpetual inventory system has become the dominant method of tracking inventory. It gives the owner up-to-the-minute inventory levels and reduces the frequency of physical counts of inventory.

More contractors are turning to software programs, tablets and bar code readers to track material sales and inventory levels. While you don’t need to do physical inventory counts as often as under a periodic inventory system, it’s still important to do them to compare against the computer records. You may uncover shortages that could indicate a theft or undocumented sales problem.

Inventory strategies have changed at the manufacturer, supplier and contractor levels over the past few decades. Terms like lean manufacturing, just-in-time and Six Sigma have become part of the everyday vernacular of manufacturers. Changes in manufacturing and inventory became an even higher priority due to the recession of 2008.

Think this hasn’t impacted our industry? Think again. Have you noticed fixtures or parts that you used to pick up from a supplier’s inventory are now special-order items? Without advanced planning, you may be forced to finish a customer’s job at a later date. This is a great example why it’s important that you know what materials you’re selling as well as the quantities of each item.

Another aspect of inventory management that’s changed is the type of vehicles that contractors are using to serve their customers. Yes, pickup trucks and cargo vans are still being used but they’re now joined by box trucks and step vans. Controlling the inventory on your trucks as well as the inventory on your shelves will save you money. Many contractors are implementing standardized inventory packages onto their service trucks. The trucks have identical shelving systems and inventory. 

A good inventory control system covers all aspects of managing a contractor's inventory: purchasing, receiving, stocking, selling and reordering. A properly designed inventory system offers the following additional benefits:

  • Lowers storage costs — properly managing your inventory will require less storage space (hence less rent or carrying costs of your shop), which improves profitability and cash flow.
  • Improves productivity of field staff — proper inventory levels means less trips from a customer’s home to a supply house to pick up materials that should be in inventory on the truck. Not having the necessary materials for the job costs the company much more than just the cost of the material that the technician has to go get. Productivity may improve enough that more customers could be served.
  • Improves close rate of technicians — it’s much easier to close the sale of a faucet, toilet or water heater if you have it on hand or in inventory where the work can be done that same day. This also has a positive impact on customer satisfaction of the company’s performance.

A newer inventory management strategy has some suppliers and contractors working closer together than ever before. It is called vendor-managed inventory (VMI). VMI is a process where the vendor (supplier) manages the contractor’s inventory for them. The contractor shares purchasing data with the supplier and the supplier stocks the contractor’s shelves and makes sure they have the inventory they need to serve their customers. In some cases, the supplier will have one of their employees stationed at the contractor’s shop to maintain the inventory. It’s a win for the supplier because the contractor typically purchases most, if not all, of his material from that supplier. It’s a win for the contractor because it will minimize out-of-stock situations and optimize inventory levels, which save the contractor money.

As my dad’s business grew, so did the breadth of parts he needed in his inventory. Hence, his business grew out of the spare room and garage of our house to a full-fledged shop and office about 10 minutes from home. The location, managing and tracking of his inventory have changed over the last 40 years. However, one thing about his inventory hasn’t changed. Wanna guess what it is? Yep, he’s still using milk cartons and crates to tote around a lot of things on his truck.

Michael Bohinc is a Certified Public Accountant in Cleveland, Ohio, and the owner of Keeping Score Inc. He has served as the Chief Financial Officer of Norhio Plumbing Inc., his family’s plumbing company in Aurora, Ohio, since 1988. He also currently serves as the Interim Director for the Service Nation Alliance – Plumbing Group. You may contact him via e-mail at [email protected]

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