Production volume, pricing and labor rates are steady. Inventory ties to the general ledger. But gross margin has dropped two points from the prior quarter, and the finance team is left searching for answers in the accounting records.
This scenario plays out in manufacturing companies all the time, but the issue usually doesn’t start in accounting (even though the finance department is tasked with explaining it). More often, it starts with inventory.
Inaccurate inventory begins as a process problem, but it can quickly become a finance problem. Resolving it requires understanding the processes behind the financial outputs.
Inventory Errors Rarely Start in Accounting
Inventory errors tend to trace back to a handful of operational habits that feel harmless on their own. For example:
- Cycle counts happen on different schedules, with varying levels of thoroughness, across locations.
- Production posts to the ERP hours or days after work occurs, creating a timing delay between physical activity and the system of record.
- Employees develop workarounds for ERP steps that slow them down, and those workarounds become the unofficial standard.
- Scrap and rework are logged inconsistently, if they are logged at all.
- Bills of material and standard costs reflect how the company used to build the products, not how products are built today.
A supervisor can explain a variance when it first appears. Over time, the workaround becomes part of the process, and nobody revisits it. The issue spreads into other areas of the operation, and the effects accumulate.
How Small Gaps Create Margin Volatility
Every one of these process breakdowns eventually hits cost of goods sold (COGS). Standard costs hide what’s happening on the floor because the team never updated the standard. Timing differences between physical activity and system entries throw off results from one period to the next. Add it all up, and you get margin trends that don’t line up with changes in throughput, labor hours or pricing.
Consider a manufacturer that builds three product lines on the same equipment. Someone substituted a component on the line two years ago, but the bill of materials (BOM) still lists the old part. Now, every unit of that product understates or overstates the true cost.
Multiply that error across a year of production and it shows up as margin volatility. And finance sees the impact long before anyone traces it back to the source.
Where Finance Looks First (And Why Reports Alone Are Not Enough)
Finance usually starts with inventory valuation, reserves, manual journal entries and the latest cycle count results to determine whether the issue is timing, an error or something else.
Eventually, reports start contradicting each other, and people explain variances with estimates instead of documentation. The numbers reconcile, but there are still unexplained variances because the real problem isn’t in the numbers.
Many business leaders assume their audit will catch inventory inaccuracies or that, if the numbers tie out, all is well. But numbers can reconcile and still fail to reflect what is actually happening in operations. Audits validate balances at a point in time; they do not necessarily evaluate how the underlying process operates day-to-day. Small inconsistencies can add up to real margin, cash flow and decision-making impacts.
You have to trace how the work actually happens, regardless of what a procedure manual says should happen.
Inventory Becomes a Credibility Issue
The issue becomes increasingly visible when reported results require repeated adjustments and different plants produce different answers to the same question. Auditors begin to ask harder questions, lenders scrutinize covenant compliance more closely, Board members lose confidence in reported results and before you know it, inventory accuracy starts affecting confidence in your business.
Internally, teams may spend more time debating the accuracy of information and less time acting on it. Pricing decisions, production schedules, capital investment decisions, working capital planning and inventory planning are built on inaccurate information, which causes further ripple effects.
Stabilizing Inventory Issues in Manufacturing Companies
Resolving inventory issues requires a mindset shift from reconciling results to understanding how results are produced.
In a manufacturing environment, that may involve:
- Tracing transactions from activity on the shop floor through the ERP system and into the financial statements
- Comparing documented processes to actual execution
- Identifying where timing breaks down
- Understanding where workarounds have become part of the process
- Determining why the same process can produce different results across plants
- Identifying where variances originate instead of focusing only on where they appear in reports
This approach connects operational activity directly to financial outcomes by replacing assumptions with observable processes and verified information.
A business process review can help identify how inventory transactions move through operations, inventory management and finance. The review follows inventory activity from the time of ordering an inventory part and into financial reporting. Actual practices are compared to documented procedures, system requirements and expected workflows across locations.
This type of review focuses on where transaction timing breaks down, where information is changed outside the normal process, where technology is creating inefficiencies, where controls are bypassed and where differences between facilities produce different results. Inventory variances are traced back to the activity that created the financial reporting impact instead of being evaluated only after they appear in reviews.
Organizations often reach this point when inventory adjustments become a recurring part of the close process, similar activities produce different financial results across facilities, finance and operations continue to reach different conclusions about the source of the problem, or long-standing inventory process issues have become accepted as “the way things have always been done.”
Inventory processes become more difficult to rely on when recurring inventory issues continue to surface and the underlying cause remains unresolved.
Learn More About Promoting Financial Health in Your Manufacturing Company
When numbers don’t match up, additional analysis often produces more questions than answers. The key is understanding how the process operates and where it breaks down.
To learn more about inventory, accounting and business process reviews, contact your Warren Averett advisor directly, or ask a member of our team to reach out to you.
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