Throwing out half of a palette of expired lettuce is often part of the job when managing a small to medium-sized manufacturer, and it may not seem like a big deal. The costs of spoilage can add up, though. In fact, inventory spoilage accounts for over $35 billion in costs to small businesses every year.
Spoilage costs aren’t always obvious, either — many business owners fail to account for how selling expired food or constantly throwing out old product can damage their reputation, for instance. Businesses need to have processes in place to identify and budget for the hidden costs of inventory management and spoilage.
Reducing inventory spoilage should be a long-term goal of every food manufacturing business. In this article, we will define spoilage, then discuss in detail how the hidden costs of spoilage affect a company’s bottom line.
What is spoilage?
Put simply, spoilage is the waste of a product during the manufacturing process. For food manufacturers, this usually means the loss of perishable items, like produce expiring or bread becoming stale. This can happen before a product is manufactured, during the process, or after it has already been made.
Spoilage can be divided into 2 categories:
- Normal spoilage is the expected amount of waste that occurs during manufacturing. For example, as a food manufacturer, you probably understand that some product will be lost or wasted during transportation, like when vegetables rot. Similarly, the manufacturing process itself often leads to small losses of inventory.
- Abnormal spoilage is more serious than normal spoilage, because it represents a loss that is greater than what is normally expected. Abnormal spoilage can result from many things, but often means some inefficiency in inventory management or the production process.
Impact of spoilage
It isn’t difficult to see how throwing out expired foods that your business has purchased isn’t a good thing. Often, small businesses have much of their total costs wrapped up in inventory, and wasting product isn’t a sustainable strategy.
Inventory spoilage has hidden costs that you may not be aware of, though. Because all inventory has a physical cost associated with it, any money that has gone toward inventory can’t be used by a business elsewhere. There are costs to maintain and store inventory, too — businesses need to pay employees to manage inventory and transport it, and they pay to secure space for storage, among other things.
These costs will impact the gross income of a business, or the amount of money that business makes after factoring in any costs. Food manufacturers should be careful to avoid having the up-front costs they pay for inventory being lost to spoilage.
How to avoid excessive spoilage
Although some inventory spoilage is inevitable, taking these 4 steps will help ensure that your business limits it as much as possible:
- Tighten up inventory procedures. Managing your inventory can be complex, especially if you are running a large manufacturing business. Start to reduce spoilage by setting and enforcing specific procedures for managing product, like tracking expiration dates, ensuring that refrigeration levels are correct, and training staff to handle inventory without loss. These ground level procedures will build a solid foundation for your inventory management.
- Automate systems. Modern inventory management software is a powerful tool your business should be leveraging to reduce waste. Invest in a management system that tracks orders in real-time and alerts you when you have over or under ordered. The data an automated inventory management system provides will help guide your strategy for avoiding spoilage costs.
- Hire someone to help. Running a business is difficult. As an owner, you often can’t oversee everything going on with your business directly. Hiring someone to manage your inventory will not only reduce spoilage costs but can relieve some stress and allow you to get back to bigger-picture work.
A virtual CFO is an expert in managing inventories — “spoilage” is, afterall, an accounting term — and a consultation with one won’t break the bank. Plus, a CFO can help you develop a long-term strategy for your inventory, so that spoilage costs remain low and ordering is efficient.
A Real Life Example
Benji Beverages (name changed for privacy) manufactures juice products that it sells to retail outlets and at its company kiosk locations through the Denver metro area. The product is not pasteurized, so its shelf life varies between 6-10 days.
The company has a target margin on its product of 55%-60%. For months, however, this margin could not be achieved. After evaluating all inputs to the product and the manufacturing process itself, the owner could not identify why they could not achieve their desired margin.
When Krieger Analytics first started working with this client, there were few controls around inventory and ordering and no process to correctly cost the product. One of the first steps we took was to document and create a manufacturing process flow chart. We soon saw there was waste going on during the manufacturing process. Second, we started to inventory the product at the retail kiosks much closer. Once we did this, we saw how much product was being thrown out due to expiring dates.
We could quickly see 4%-7% gains in the margin with these two changes alone due to waste and spoilage. By identifying this, the owner was able to make changes to their processes and procedures. Within 3 months, they were achieving the lower target of their desired margin.
How Krieger Analytics can help
Krieger Analytics specializes in outsourcing accounting services for small businesses, from bookkeeping to virtual CFO consultations, and our background in entrapuernship and finance means we know what running a business entails. Our goal is to meet your small business accounting needs without burdening you with the costs of a full-time accounting staff. And, we understand your position as a franchisor, because we have experience running franchising businesses ourselves.
Have questions about anything discussed in this article, or interested in what valuable insights a CFO and former franchisor has for your business? Conversations are free, so don’t hesitate to reach out at [email protected], and let us explain how our services could be the right fit for you.