by Rene T. Domingo (email comments to rtd@aim.edu)

A large number companies, of various sizes and industries, are losing money because of excessive inventories of all sorts: raw material, in-process, and finished goods. One symptom of this business cholesterol is the huge interest expense that usually wipes out operating profit and prevents it from reaching the bottom line. Many managers, in order to escape responsibility or out of ignorance, generally explains away this expense by citing the high cost of financing or materials, when in fact most of this interest pays for the working capital that maintains unnecessary and avoidable inventories. Like fat and extra weight, excessive inventories and the resulting interest expenses drag any business operations. And this disease does not spare even those with healthy market shares or high sales growth rates and could wipe out or reduce profits to a greater extent.

Inventories are mystifying and mesmerizing. Management usually cringes when it sees mountains of defects, scrap, or reworks and usually are fast in reprimanding those responsible for this easily perceived wastage and in ordering countermeasures. But it seldom views overproduction and excess inventories as problems when it fact they cause more drain on corporate resources than quality problems. Nobody minds the idle inventories that inhabit the omnipresent shelves, racks, stockrooms, warehouses, and even shop floors. These inventories are actually potential gold mine of savings.

Some generally accepted accounting practices that are generally misleading encourage this indifference to inventory problems. One is to permit the inclusion of inventories in the balance sheet as assets at their purchase or manufacturing costs. Now costs have nothing to do with value - or saleable value. For instance, though half of the inventories are accounted for obsolete items, canceled orders, and overproduction, they are all carried as corporate assets at full costs when in fact they are of dubious value and condition. The fact that excess inventories, especially finished goods, CAN be sold is no guarantee that they WILL be. This argument is usually given as a flimsy excuse for poor inventory and production planning.

Another misleading accounting practice is to classify interest as NON-OPERATING expense, when in fact most of it may be due to bad OPERATING decisions - overbuying of materials, overproduction, investment in excess capacity and equipment. (Even huge and slow-moving accounts receivables that must be supported by substantial working capital and interest payments may be due to poor collection procedures and receivable management - all operating decisions.) Because of this misclassification, when interest expense surges, management usually blames the finance manager who in turn attributes it to the banking system, economic conditions, money supply, etc. In short, nobody assumes responsibility, the problem remains unsolved, and the financial haemorrhage unchecked. Unsummoned, the purchasing manager and the production manager continue with their old ways, mindless of the fact that their everyday decisions chew away corporate profits.

Nobody likes to see idle capacity. Who wants to see a million peso equipment sit idle? Who wants to see a worker stand idle while waiting for customer orders? To justify capital investments or to hide excess capacity, many companies operate and produce continuously in excess or in anticipation of market demand. But they have merely replaced one evil -idle capacity - with a greater evil - idle inventories. It has been shown that idle inventories are costlier to maintain than idle capacity. Inventories are much more subject to obsolescence, spoilage, theft, fire, and consumes much more space, labor, and a host of other overhead.

Japanese companies gained a head start in the business game by discovering early that the key to profitability and productivity is to minimize (not optimize) all kinds of inventories. The Toyota group of companies spearheaded this movement and pioneered the Just-in-Time (JIT) manufacturing system that is now being imitated by almost all other Japanese companies and even major American companies like GM, Ford, Chrysler, Timex. The JIT principle is simple: produce only what the customer needs, when he needs it, at the amount he needs. "Customer" has a broader definition: it includes not only the ultimate consumer or buyer, but all processes, operations, and departments in the factory. In short, one operation will not produce more than what is required by its subsequent operation. It is like applying the fast-food concept to the production of industrial and consumer goods. By applying JIT, Toyota has substantially reduced inventories of finished goods, in-process, and raw materials, space required to maintain these, interest expenses, and other expenses inherent in carrying inventories.

Moreover, JIT has significantly improved product quality, workers' sense of responsibility and teamwork, and cut production lead times. With this system, Toyota has consistently been Japan's no. 1 manufacturing company in terms of sales, profits, and cash - without maintaining any warehouse. Other companies that have applied JIT have reaped similar benefits.

JIT shows that a healthy and profitable company is lean and flexible - lean in inventory, capacity, and manpower. Its major strength is ultra low-cost operations that will enable it to survive and compete in the fierce domestic and international markets.