It’s the time of year for daydreaming about creatively using leftovers. What if we apply some of that daydreaming time to thinking about how to spend leftover inventory budget? Stretch yourself by thinking of 11 ways to spend it, if you can. And let’s top off this riddle by thinking through whether leftover inventory budget truly exists in your business.
Setting the inventory budget
Companies create their forecasts and financial plans, setting revenues and cost of goods sold, and creating a budget for expenses for the year(s). Excellent companies create these financial plans and budgets:
- by month
- with rolling quarters that continually update
- that include at least the next four rolling quarters
- to generate a 12-month forward outlook.
Financial plans are presented as financial statements for a future period of time, including:
Income statement, otherwise known as profit and loss statement
The budget for your business is detailed by expense category. You create the budget using accounting software that contains a budget calculator. The software automatically summarizes the accounts as designated categories in the income statement. Accounting and budgeting software also calculates the cost of goods sold automatically. Some small business retailers calculate ending inventory during the year using gross profit margins applied to sales plus beginning inventory and purchases. Calculating inventory with gross profit margins isn’t as accurate as a physical inventory that is taken at least once a year.
The forecast balance sheet includes the inventory budget because inventory is an asset account. Inventory categories vary by type of business.
Manufacturing firms have raw materials (which is purchased inventory), work in process, and finished goods inventory. Work in process inventory includes raw materials (that is transferred from raw materials inventory), labor costs incurred in manufacturing the product, and manufacturing overhead costs, consisting of both fixed costs and variable costs. Manufacturing firms often use standard costing systems that assign predetermined costs per hour or other unit of manufacturing.
Retailers and wholesalers have finished goods inventory.
Cash flow statement
The indirect cash flow statement treats the change in total inventory balance for the time period as a line item adjustment to net income in the cash flow from operations section. Inventory affects working capital.
Is there leftover inventory budget when you use flexible demand-based budgeting?
While some very small businesses may only determine their inventory budget once a year, more sophisticated businesses use a flexible inventory budget based on existing inventory balances and at least monthly forecasts of sales demand.
In manufacturing companies, the process is called master production scheduling and material requirements planning. Inventory requirements are projected, and purchases are made as needed to meet the manufacturing schedule. Some manufacturing companies like Dell use just-in-time inventory that orders inventory as required to meet demand and minimizes in-stock inventory levels.
If you can have leftover inventory budget, what are the 11 ways that you would daydream about using it?
Here are some possibilities to start your thought process. Daydream about the list that fits your business.
- Invest in accounting software that can handle forecasting and inventory.
- Buy additional inventory to meet future sales demand (if you expect higher sales activity soon).
- Rent additional warehouse space, if needed, to store the extra inventory that you purchase or manufacture now.
- Increase the number of manufacturing hours in your schedule to produce the additional inventory that you’re investing in now.
- Hire one extra staff member to take periodic physical inventory counts based on samples more often and do other accounting tasks too.
- If it’s due to less inventory shrinkage from theft and loss, congratulate yourself and think about spending it on employee bonuses.
- Invest in marketing and sales to increase the sales level, increasing the need for future inventory purchases.
- Take a refresher course on the topic of flexible budgeting.
- Analyze variances to see how you were able to successfully reduce manufacturing overhead, labor efficiency, and scrap rates in a manufacturing company. Then repeat the process. Invest in other areas of the business if your company has team players. Otherwise, invest in another category of your budget.
- Buy equipment that would reduce variable labor costs in manufacturing if you can justify the cost-benefit.
- Throw a party to reinforce the company’s positive corporate culture.
It’s always fun to daydream about what you would do with unused budget categories. Is it real, or is it beyond your reach because the inventory budget is continuously resized through flexible, demand-based budgeting? Evaluate the reasons why you’ve spent less on inventory. And if you don’t reach your planned sales level, would you have extra cash available to spend in different ways?