It is my job (mission?) at Business Accounting Mastery to get us, as accountants, to think in ways which are not necessarily in line with “conventional thinking”. You know, rock the boat a little bit. Let’s face it, innovation and change permeate throughout our society at a ridiculous pace through technology and other advancements. However, for the most part, accounting remains stuck in the 19th century.
One of the easiest ways to get this thinking started, for me at least, is to take a look at inventory. Yes, that giant monolithic group of widgets that takes up an outsize portion of your factory. Inventory. Along with cash (hopefully) and property, plant, and equipment, it is probably the largest item on the assets side of your company’s balance sheet. An asset indeed, right? Product just itching to be sold to a customer to solve their needs. Ready to be transformed into a receivable and ultimately cash. There is nothing that fulfills the definition of an asset more than inventory.
That’s what we were taught as baby accountants, right? When we first started in accounting 101, it was clear as day. Inventory is an asset. Well, lets back up a minute and look at the definition of an asset, thanks to Wikipedia:
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset. Simply stated, assets represent value of ownership that can be converted into cash.
Seems simple enough, right? We own inventory. We aim to convert inventory into cash. We control inventory to produce value. Seems simple enough.
But, it is all a lie.
I’m here to tell you inventory is the biggest LIABILITY on your balance sheet.
Huh? How is THAT possible? Hear me out.
Here’s some reasons why inventory is a liability in my mind.
- Inventory can become obsolete – Engineering changes a drawing. The customer no longer wants the product offering. The roof leaks and warps the widget. As long as a part is sitting in the stockroom, it is at risk of any number of these events happening to it.
- Inventory ties up resources – Our organizations aim to generate cash. That’s how we fulfill our missions. However, just imagine what could be done with the gigantic lump of cash that is tied up in inventory.
- Inventory takes up productive capacity space – Need a plant addition? Or do you just need to cut back inventory? How many productive machines and cells can be jammed into the space your inventory takes up?
- Inventory represents US guessing what the customer wants instead of the customer telling us – We can use all of the fancy forecasting processes that we wish to. We can implement the shiniest MRP system out there. But, when it comes down to it, it is all an educated guess as to what the customer is going to want. We don’t know what they will want until they tell us. Not a minute before. Inventory is our crutch in case we are wrong.
That last one is the biggest one in my mind. Inventory ends up being an illusion built to convince ourselves that we are serving the customers needs satisfactorily. In fact, we are doing the OPPOSITE. We are tying up finite resources (i.e. cash) in parts that could be deployed elsewhere. Like what? Here’s just a few more things we could redeploy cash to if it wasn’t tied up in inventory
- More machines to reduce lead time
- More labor to run those machines
- More engineers to develop new products our customers are clamoring for
- Better wages and benefits to retain high performing staff
This is all why I consider inventory to instead be the most significant LIABILITY on an organization’s balance sheet. Not an asset at all. Inventory represents a outsized risk that needs to be mitigated.
Instead, as accountants, we need to provide the organization information that helps our operating groups reduce inventory. Instead, we should be focused on process improvements that allow us to better react to customer demands. This means processes that have less waste and lead times that are shorter. The more nimble we are, as an organization, the quicker we can respond to a customer order. The shorter our lead times get, through process improvement, the less inventory we need on hand to handle spikes in demand.
In the immediate term, inventory is a necessity. However, in the long term, it should be eliminated. The organizations that do reduce their reliance on inventory are going to be the ones who have more resources at their disposal to grow their businesses. I’ll put my money on those companies to win in the end.
What do you think of inventory? Asset or Liability?