How accounting caught two hidden ERP inventory errors

Here’s a quick story about how detailed accounting and monthly reviews helped catch two inventory and system errors at a modular company.

Comparing every project to its estimate

Every month, and after each project is done, we look at the budget used to price the project. Then we compare it to how the project really did. And we get granular.

Estimates are usually built by builders and designers with years of experience in factories and on the floor. They know a mispriced project can be the difference between a profitable year and an unprofitable one, so they take it seriously. The goal is a fairly accurate material and labor price, based on the square footage and how complex the build is.

At the end of a project, it’s always important to see how it matched up against what was really spent, and to figure out WHY. Do estimates need to change in the future? Are there lessons to learn from this project? Were there project or customer red flags that got ignored that won’t be ignored next time? Those lessons help the management team keep getting better. Then they trickle down to everyone in the company, from the factory floor to the sales team out getting deals signed.

The numbers looked too good

For this client, projects kept coming in well below the material cost per square foot used when the project was scoped. Suspiciously lower...

So we dug deeper! Even at a big-picture level, something was clearly off. We took the total square feet the factory built that year and compared it to the total material cost in the books. The material cost per square foot was a full 20% lower than the estimate. That made every project look a lot better than expected!

Great if true. But a swing that big can only mean two things. Either the estimate is wrong. Or material isn’t being expensed the right way as it’s used.

Testing the estimate first

You can test an estimate by walking through the steps used to build it. Take a shipment of lumber, bought in bulk at a set price. Including waste, how much of that lumber does it take to build a certain number of square feet? We followed that process and tested each “input” to the estimate. We quickly decided the estimate wasn’t the problem. More likely, something was being coded wrong, or the system was failing somewhere.

What we found in the ERP

So we dug into the ERP system. For this customer, the ERP is separate from the accounting system. But the ERP drives the inventory and material expense numbers in the accounting system. Digging in turned up two major issues.

Error 1: a count typed in the wrong unit

The first was material counts keyed into the ERP wrong. For example, say a warehouse stocks rolls of sealing tape. Each roll holds 60 yards and costs $25. During a count, someone measured what was left on the shelf, 1,800 yards, and typed “1,800” into the system. But the system counts tape in rolls, not yards. So now it believed there were 1,800 rolls worth $45,000. The real number was 30 rolls worth $750.

That was the first error we caught, and it got fixed fast. Keying errors aren’t all that uncommon. But this one made inventory look bigger than it was. It didn’t change what was expensed to any project. It only made the inventory number on the balance sheet too high.

Error 2: parts that never got charged to a project

The second error, which I believe was the real culprit, was on the factory floor. Workers didn’t always record the parts they grabbed off the shelf to finish their station. Sometimes they charged them to the wrong project. Sometimes to no project at all. So parts used on a project stayed in inventory. They never got expensed to that project. Inventory looked higher than it really was, and material expense looked lower than it really was.

By the time a count is done, it’s usually unclear which project the parts were used on. So the difference gets recorded as one stock adjustment.

Here’s how the two errors fit together. Both made inventory on the balance sheet look bigger than it was, but in different ways. The tape typed in the wrong unit was a quantity mistake. It inflated the dollar value of inventory, but it never touched project costs. The parts that never got charged to a project did more damage. Those parts WERE used in the build. They just never left inventory in the system. So inventory stayed too high, and project material costs came in too low. That second error is what drove the 20% gap. What looked like one suspicious thing was really two fixable errors. Both came from parts and materials not being recorded or tracked right in the ERP.

Why a high-level review won’t catch it

The trickiest part is that the ERP was wrong, so the accounting system was wrong too. The books and the ERP agreed with each other. They were just wrong by the same amount. No high-level review or reconciliation would have caught it. Only the in-the-weeds, gritty review, where you go through each line one at a time.

There is a saying in accounting that is: Trash in, trash out. What that means is basically if the foundation of your financials is built on bad data, then no matter what accounting you do the output is also going to be bad. And the tricky thing is root errors like this are always the hardest to catch. You need an outside check to find them. In this case, the outside check was the estimate from experienced team members. That’s what caught the issue before it grew into something bigger.

What it costs if nobody catches it

• Inventory is too high. The balance sheet shows parts that don’t exist anymore.
• Job margins look better than they are. The jobs that used the parts never carry their cost.
• Purchasing gets bad signals. They see stock that isn’t there and don’t reorder until it runs out.

How to keep it from happening

• Make recording parts part of the job. Nothing leaves a shelf without being charged to a project.
• Move parts in the system the day they ship. Use the bill of materials to know what went out.
• Count the stations often. Start with the highest-dollar items.
• Add simple checks. Flag any count where the value is way off from the purchase price. That one would have caught the tape.

So this is your reminder: review your projects against the estimates, and take the differences seriously. If you want help with this kind of review, book a call here.