Strategies to Reduce Manufacturing Inventory VariancesDoes your manufacturing company have inventory production variances that significantly impact the financial statements?

10/16/2024 - By Carol Rosenblatt, CPA, CIT

Does your manufacturing company have inventory production variances that significantly impact the financial statements? Are you looking for ways to minimize variances, improve financial reporting, and manage the business better?

Standards should typically be updated annually. Historical data should be used as a benchmark in determining standards. Economic volatility and anticipated material, labor, and overhead prices should be heavily considered in creating the standards. When production varies significantly from month to month, manufacturing companies need to adopt a more frequent and flexible approach to revising standard costs and minimizing capitalized inventory manufacturing variances.

The following strategies can help you update and maintain standard costs to minimize the impact of manufacturing inventory variances on the financial statements and improve financial reporting.

Regular Financial Analysis and Standard Cost Revisions

Annual Reviews
Many manufacturing companies conduct annual reviews of standard costs to coincide with the fiscal year. This allows them to incorporate any changes in material prices, labor rates, overhead costs, or production processes that have occurred over the past year.

Quarterly or Semi-Annual Reviews
In industries with significant market volatility or rapid changes in input costs, quarterly or semi-annual reviews of standard costs may be more appropriate. This frequency allows companies to react quickly to changes in market conditions and adjust standard costs accordingly.

Continuous Monitoring
Some manufacturing companies adopt a more dynamic approach to standard cost management by continuously monitoring key cost drivers and updating standard costs monthly. This approach may involve real-time tracking of material prices, labor rates, and other cost components to ensure standard costs remain accurate and up-to-date.

Trigger-Based Revisions
Standard cost revisions may also be triggered by specific events such as changes in supplier contracts, production process improvements, or significant fluctuations in input costs. By establishing clear criteria for when standard cost revisions are necessary, companies can ensure that standard costs accurately reflect current conditions.

We suggest determining a specific threshold of change that will trigger an analysis of standard cost variances. For example:

Significant changes in sales demand and production volume
Raw material cost per pound variances over 5-10% of the standard
Manufacturing yield variances over 5-10% of the standard

When triggering events occur, we suggest selectively adjusting standard costs on a more frequent basis. For example:

Update overhead standards monthly or quarterly, based on expected production volume
Update raw material standards quarterly
Update direct labor standards semi-annually

Dynamic Costing Models
Implement dynamic costing models that can quickly adapt to changes in production levels and input costs. These models should incorporate real-time data on production output, material usage, and other cost drivers to calculate standard costs accurately each month.

Additional Considerations on Reducing Inventory Variances

Optimize Production Planning
Enhance forecasting accuracy by integrating historical sales data, market trends, and customer demand forecasts. Use advanced analytics and predictive modeling to anticipate fluctuations in demand and adjust production accordingly. By aligning production levels with expected demand, you can minimize excess inventory buildup and reduce variance fluctuations.

Monitor Key Performance Indicators (KPIs)
Continuously monitor key performance indicators related to inventory management and manufacturing variances. Track metrics such as inventory turnover, days of inventory on hand, and variance to standard cost to gauge performance and identify areas for improvement.

Cost Control Measures
Implement cost control measures to reduce manufacturing expenses without compromising quality. Identify areas for cost optimization, such as production efficiency improvements and scrap reduction initiatives.

Expert Advice

We understand the financial and operational issues of the manufacturing and distribution industry. Whether your company manufactures metal products, electronic products, plastics, machinery, food products, or other goods, our team of experts provides cost-effective solutions to help you achieve your goals. Contact us or join our email list to receive insights from Saltmarsh.

About the Author | Carol Rosenblatt, CPA, CIT
Carol is a director in the Audit & Assurance Services practice of Saltmarsh, Cleaveland & Gund. She began practicing public accounting and auditing in 1994 and spent more than 15 years working for an international firm prior to joining Saltmarsh in February 2010. Carol’s primary areas of experience include supervising the audit and review process in industries such as employee benefit plans, non-profit, construction, and manufacturing.