When a supplier quotes you a great price, it’s very tempting to buy materials in bulk and use them over several jobs. You only have to look at the success of warehouse stores to see how hard this is to resist. Contractors often buy in bulk, thinking it will save the company money and increase its profits. Sometimes it does. And other times it doesn’t. Without efficient inventory management, these savings can be squandered, or, even worse, you can lose money on your inventory. This article looks at some of the things you should consider when thinking about buying in bulk and inventorying the surplus for use on future jobs.
Key Takeaways
- It can be very tempting to buy materials in bulk when a supplier offers you a great price, but it is not always a sound business decision.
- Buying materials in bulk and storing the surplus for future use is not a decision to be taken lightly. You need to consider not just the initial cost savings but also the cost of storing and shipping the materials to the job site. And let's not forget the interest cost on the cash you've invested in these purchases.
- When you decide to maintain an inventory, it's crucial that you set up a robust accounting system and establish effective management procedures for tracking the inventory and allocating its cost to the jobs. This process demands significant time, financial resources, and effort.
The Pros and Cons of Carrying an Inventory
Construction companies may find it profitable to order some construction supplies and consumables (like fasteners) in bulk and store the extra materials in inventory for future projects. When the materials are needed on a construction project, the inventory items are shipped from the storage location to the job site.
Ordering construction materials in bulk can help construction companies get better pricing and increase profitability. Keeping needed materials on hand also helps in case of shortages and supply chain delays. Inventorying commonly used materials can reduce downtime due to material shortages and the increased construction costs associated with lost productivity while waiting for materials. And of course, anytime you can reduce construction costs, the cost savings go straight into your profit.
However, using inventories comes at a cost, which may eat into your savings from buying the materials in bulk. These inventory costs reduce your profit and, in some cases, may exceed the money saved by buying in bulk. Here are some ways that having an inventory costs you money.
- Most importantly, inventory ties up your cash, which can strain your finances. Because materials in inventory can’t be billed to a job until they are shipped to the job, you need to fund the purchase of these materials until you are ready to use them. There is a very real interest cost of tying up your cash in inventory.
- The costs of keeping an inventory are very real. You must store them in a secure location and ship them to the construction sites when they are needed.
- Managing the inventory can be time-consuming for the project management team. The time your team spends tracking and managing the inventory distracts them from their other duties.
- When workers see the material supplies as unlimited and readily available, they are less likely to use them carefully. For example, when plenty of materials are available, it is easier for workers to grab a new piece of lumber to cut for blocking than to use lumber from the scrap pile.
- You assume the risks of owning materials you can’t use and having materials lost due to theft or damage. Obsolete, stolen, and damaged materials cost you money. Anytime you have an inventory, at least some of these losses are inevitable.
Keep in mind that it is not the money you save by buying in bulk that shows up as profit. It is only the amount you save over and above the costs of carrying an inventory. And if the cost of carrying the inventory exceeds the savings from buying in bulk, you are losing money.
The Construction Inventory Workflow
When you buy materials in bulk and inventory the surplus materials, you need to set up separate accounting and asset-tracking procedures for the inventoried materials, which are different from those you use for materials shipped directly to the jobs. Here’s what that workflow looks like:
First, you begin by determining the desired inventory levels by forecasting what materials will be needed on the jobs for a specified period of time. This should include a target inventory level and a reorder level. The target inventory level establishes the upper inventory limit for the materials and is the amount of materials you want in inventory just after receiving an order. The reorder level is the minimum amount of materials you want to keep on hand to make sure that materials are reordered with enough lead time to prevent stockouts. When selecting these levels, you must carefully balance the cost savings from buying the materials in bulk against their inventory costs.
Second, you use the same procurement process as you would for a construction job, except the purchase order is coded to the inventory asset account rather than a job, and the materials are delivered to the inventory storage area. Holding inventory requires you to include an inventory account on the balance sheet that shows the value of the inventory. When purchasing inventory, you are exchanging cash (an asset) for another asset (inventory); as such, construction costs are not recorded at this time.
For example, if you purchase a pallet of nails for a framing crew, the cost of the nails would be recorded as one of your company’s assets. The bill for the nails would be treated as an accounts payable, and eventually, cash would be used to pay the bill.
Third, when the materials are needed on-site, you ship them to the project, and you use a work order or other inventory tracking paperwork to document their usage. You then remove the cost of the materials shipped to the job site from the inventory and treat them as construction costs, as you would with any material bill.
For example, if you sent two boxes of nails to the job site, the cost of the nails would be removed from the inventory, reducing the company’s assets. These costs would be charged to the project’s construction costs and recorded as an expense on your income statement and as a job cost in the job cost ledger.
It is critical that you track the usage of inventory and charge its cost to the jobs. If you fail to do this, you are understating the job’s construction costs, making them harder to control. These costs should also include allocating the interest, storage, and shipping costs associated with the inventory.
Fourth, you periodically check the stock levels and reorder the materials when they fall below the reorder level. The amount of materials you order is the difference between the target and current inventory levels.
Fifth, you should periodically review the target and reorder levels. Things change. The correct inventory levels for today may be the wrong levels for next year.
Finally, good inventory control requires that you periodically audit the inventory counts and reconcile them with the quantities in the accounting system. Inventory will be lost or damaged, and sometimes, it will become obsolete. The value of the inventory asset account will need to be adjusted to reflect the actual materials in inventory at their purchase price and only include that inventory that you expect will be used on future projects. This typically involves writing off some of the inventory, which your accountant can help you with.
Construction Inventory Management Tools
There are several tools that the construction industry can use to streamline the inventory management process. One of the best solutions is when the inventory management software is incorporated into your accounting package. This eliminates the need to transfer data from your inventory tracking system into the accounting system.
If you are like many small businesses, you may not be able to afford construction inventory management software. In this case, spreadsheets may be used to track inventory data. If you have a large inventory with hundreds of items, investing in an inventory management system that uses barcodes, QR codes, RFID tags, or mobile apps to track your inventory in real time may be a cost-effective solution.
When looking at inventory management tools, you should consider the software’s functionality, the level of automation, the implementation timeline, and whether the provider will be there to support the software.
Final Thoughts
Maintaining an inventory is not for everyone. For some companies, keeping a supply of frequently used materials on hand makes sense. For others, it makes sense to pay a little more for the materials and let the suppliers assume the risk and costs associated with holding an inventory. Before buying materials in bulk, you should carefully weigh the cost savings against the time and cost of maintaining an inventory.
Further reading: Foundations of Construction Project Management