At times the question arises of how to best manage inventory cost.  In manufacturing operations, the role of finance is usually a partnership with operations related to inventory – cost reduction and management, inventory valuation, and appropriate inventory levels to maintain.  The partnership works best where each team’s feedback matches responsibility in the partnership.

At Tensoft, we are strong believers in the benefits of standard costing (compared to actual costing).  Standard cost is commonly associated with a swift inventory value that streamlines transaction processing and at times is viewed as ignoring the reality of inventory value as it changes.  However, we believe this is the result of a lower level of engagement that is required in any organization actively trying to manage inventory value.

When manufacturing and finance partner over inventory costing (and cost reduction) using a standard cost model, you can think of standard cost as a plan.  You are setting goals for what inventory cost should be based on the inputs and manufacturing requirements.  Variances identify reasons for moving away from the plan – such as yield hits, productivity (units absorbed for throughput), PPV variances, rework variances, and so on.  Correctly identifying and categorizing the variances allows manufacturing operations and finance to review why the goals were not met, and what the specific variances tell you about not meeting the goals.  Approached in this way, standard costing plus variance analysis actually requires the most active engagement in cost modeling and results management – setting a plan and measuring performance against the plan. 

Years ago I met with the VP of Operations of a high volume electronics component company who told me their inventory cost reduction committee met weekly – a finance and operations partnership.  Their stated goal was to reduce the cost of inventory value by $.01 each week, which achieved a $0.52 cost per unit reduction annually.  For them this amounted to millions of dollars in additional margin each year.  Results like that aren't possible unless you have an active engagement through standards (plan) and measurement (partnership review).