The 3 rules to manufacturing industry accounting
In the current market environment, manufacturing companies strive to shorten the order-to-ship timeline by increasing capacity and revenue while using fewer resources. This is referred to as “lean manufacturing”. The main idea to be aware of when thinking about accounting for the manufacturing industry is that, as operations change, so should the way the finances are conducted. Manufacturing companies need to adopt “lean accounting” methods.
Small and medium sized companies are already naturally transitioning to this type of thinking because they have small accounting departments. In this environment, the accountants generally have a more “real time” concept of where the company stands financially at all times. Some even close the books at the end of each day. This helps the operation stay lean because it identifies over-production quickly.
Large companies tend to rely on the traditional GAAP methods, which usually call for closing the books once a year. The error in this approach is that the things you need to know, like cash flow, inventory status, etc., should be monitored in a much timelier manner. By the time you realize you’re stockpiling too much inventory, for example, it’s too late to reverse the error. As a result, the rules for accounting in the manufacturing industry need to be adjusted.
What you need to know
Most people currently working in accounting departments have been taught cost accounting. In this model, inventory is considered an asset. On a traditional asset/liability balance sheet, a large supply of inventory is considered a value added and is associated with good financial standing. Sitting on a warehouse floor, however, unsold inventory is not an asset; it’s actually a liability. Using traditional accounting principles, the company would look flush, but a stockpile of unsold goods reduces the bottom line.
Inventory also does not pay the bills, so the more important metric in this industry is the revenue stream. While lean manufacturing strives to reduce time and cost per unit, lean accounting focuses on cash flow rather than asset-based accounting.
What you don’t need to know
It’s important to understand why the accounting methodology needs to be adjusted, but not so with regard to implementation. To ensure a smooth transition, you always have the option to hire a CPA. He or she can audit your books and perform a reconciliation to get a good concept of the current financial situation, and recommend the best steps going forward.
Make sure you find a consulting firm, like GYL, who has professionals with experience working as a CPA for manufacturing business. We have experts on staff that can help you get your books up to the latest standards of lean accounting and ultimately improve the bottom line.