Make a Clean Sweep: Understanding How Waste Affects Your Bottom Line

KEN L. TORNHEIM, CPA, CFE

The goal of profitable manufacturers is to make as many products with as few resources as possible. With the economy continuing its uncertain path, getting ahead of cost savings is important. One way for manufacturers to save is to rein in waste at their facilities, but waste is much more than just scrap materials that pile up on shop floors. Let’s take a look at how efficient production is the start to reducing waste.

Operating more efficiently

Preventive maintenance, routine physical inspections and effective quality control are the keys to operational efficiency. For example, do you conduct ongoing maintenance on equipment? Doing so can ensure that each machine is properly calibrated and running smoothly. Maintenance schedules can prevent unexpected breakdowns and leaks that drain electricity, gas, oil, coolants and so on.

Another part of preventive maintenance is replacing equipment on a regular basis. No machine lasts forever. New equipment can help speed up production, minimize defects and lower energy costs.

Related Read: Waste Not, Want Not: Audit Warehouse Operations for Inefficiencies

Finding solutions

Efficient production starts with waste reduction efforts. Besides preventive maintenance, other ways to help reduce waste include:

• Managing Inventory
  Having the right amount of inventory can help reduce waste through risk of loss, decay and damage. You should order only the materials needed for production for a specific period. This will require you to review past years’ sales data to estimate how much you need to produce. Now is the time to stop manufacturing less profitable products.
• Scheduling Walkthroughs
  On the first workday of the month, get into the habit of walking the plant floor and pausing to observe the production process. Look for such issues as how much time machines and employees sit idle and whether workflow seems to be organized. Examine the flow of materials. Revising the flow to be more linear and moving raw materials closer to the production line are simple ways to minimize idle time and transport. 
• Updating Workspaces
  Pay attention to whether locations are clearly delineated. You may occasionally need to update signage or repaint lines on the floor to help employees function more efficiently. Likewise, look for broken, dusty or expired inventory items. Slow-moving inventory is a waste of working capital.
• Determining Defect Causes
  Always look for the underlying cause of quality issues and fix it. For example, link defects to a specific employee (who may simply need better training) or a machine (that may need to be repaired or replaced).
• Recycling When Possible
  Consider recycling opportunities. To illustrate, you may reuse rinse water in the cooling system. Additionally, scrap can be melted and returned to raw materials or sold to a recycling yard, rather than thrown in the trash.
• Tracking Waste
  Most manufacturers already track energy and water use at their facilities. Tracking waste is not so different. Start by creating a team, and include representatives from all levels of your company. This team will gather, analyze and implement waste-reduction goals, then monitor the waste-reduction progress and report back to employees. You can promote the goals to employees, even offering monetary incentives or noncash awards.
• Conducting a Professional Waste Audit
  Every manufacturer needs quality inspections to detect waste and prevent defects from recurring. It may make sense to hire a professional to conduct a waste audit. This person can help review your waste streams and provide guidance on ways to reduce waste. Consider conducting the audit just after your year-end inventory count. You will have your inventory organized and can see where you may have waste.

Time for a fresh start

Excess scrap can lead to safety issues, cleanup costs and diminished profit margins. However, waste extends beyond trash in a manufacturing context. Now may be the time to look for fresh perspectives on waste reduction and ways to boost your bottom line. Contact your CPA to review your manufacturing processes and schedule a professional waste audit if necessary.

For more information, contact Ken L. Tornheim at [email protected] or call him at 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.

Are you doing enough to combat fraud?

HARRY FOX, CPA, CVA

Occupational fraud — that is, fraud committed by employees — is a significant problem for all businesses. According to the Association of Certified Fraud Examiners (ACFE), organizations lose 5% of their revenue to fraud every year, and manufacturing is among the most frequently hit industries.

The ACFE’s Occupational Fraud 2022: A Report to the Nations is based on data supplied by certified fraud examiners around the world. The report examined 2,110 fraud cases in 133 countries, with a median loss per case of $117,000. Manufacturers were involved in 194 cases, with a median loss of $177,000 — significantly higher than the overall median loss.

Related Read: Fending Off Fraud with Good Internal Controls

Know the common schemes

The ACFE has identified three common categories of occupational fraud:

• Asset Misappropriation (86% of cases)
  This occurs when an employee steals or misuses the employer’s resources. Examples include billing schemes, inventory theft and payroll fraud.
• Corruption (50% of cases)
  Bribery, conflicts of interest and extortion are common examples.
• Financial Statement Fraud (9% of cases)
  In these scenarios, an employee intentionally causes a material misstatement or omission in the organization’s financial statements.

Note that these numbers total more than 100% because many cases involve more than one type of fraud. In the manufacturing industry, the most common fraud schemes are corruption, billing schemes and noncash misappropriations.

In a billing scheme, the perpetrator causes the employer to issue a payment by submitting invoices for fictitious goods or services, inflated invoices or invoices for personal purchases. For example, a fraudster might create a shell company and bill the employer for services not actually rendered.

Noncash misappropriation involves stealing or misusing the employer’s noncash assets. Examples include stealing or misusing inventory, equipment or confidential customer information.

Stay in control

Implementing antifraud controls is an effective way to combat fraud. Indeed, nearly half of the cases in the ACFE’s report were attributable to either lack of internal controls or management override of existing controls. Generally, the presence of antifraud controls is associated with lower fraud losses and quicker detection.

The ACFE evaluated the effectiveness of different antifraud controls. In terms of reducing losses, the following controls reduced losses by 50% or more:

• Job rotation/mandatory vacation;
• An employee hotline; and
• Surprise audits.

Other effective measures include proactive data monitoring/analysis, an antifraud policy, fraud training for employees, formal fraud risk assessments and an employee code of conduct.

As for shortening the duration of fraud schemes, proactive data monitoring/analysis, surprise audits and job rotation/mandatory vacation were the most effective controls. These measures helped lower the duration of fraud schemes by 50% or more. Conducting formal fraud risk assessments, as well as creating a dedicated fraud department, function or team, were slightly less effective at reducing fraud duration.

Use effective precautions

Notably, some of the most effective controls are underutilized. For example, job rotation/mandatory vacation and surprise audits were each associated with at least 50% reductions in both median fraud loss and median fraud duration. But the ACFE found that they are among the least commonly implemented controls. Surprise audits were used by just 42% of the victimized organizations in the ACFE’s report, while only 25% of the organizations had job rotation or mandatory vacation policies in place.

The ACFE found that tips from employees or outside parties were the detection method in 42% of the cases in the report. Consistent with previous ACFE studies, tips are by far the most common way that frauds are discovered, underscoring the importance of hotlines for reporting fraud and other violations.

The ACFE reported that fraud losses were two times higher at organizations without hotlines. Email and web-based reporting both surpassed telephone hotlines, so it is best to provide multiple reporting channels. The report also found that reports of fraud are more likely to be submitted via hotlines if employees receive fraud awareness and reporting training.

Related Read: What Can You do to Prevent Employee Fraud?

It can happen to you

Many manufacturers, especially smaller ones, view antifraud controls as unnecessary. You may feel that you know and trust your employees, and it cannot happen to your company. But there may be motivations outside of your control, such as personal financial distress or gambling addictions, that can lead good employees to make bad decisions. By implementing antifraud controls, you can minimize the opportunities for fraud to happen at your company.

The most effective controls for your company depend on a number of factors and can vary by industry. It is a good idea to benchmark your company’s antifraud controls against those of your peers. Contact your CPA for help fortifying your defenses.

Sidebar: Recognize fraud warning signs

To effectively detect fraud and minimize your losses, it is important to recognize certain employee behaviors that can be a red flag for fraud. According to Occupational Fraud 2022: A Report to the Nations, a biennial report published by the Association of Certified Fraud Examiners, the eight most common red flags are:

1. Living beyond one’s means;
2. Financial difficulties;
3. Unusually close association with a vendor or customer;
4. Control issues and unwillingness to share duties;
5. Irritability, suspiciousness or defensiveness;
6. Bullying or intimidation;
7. Divorce and/or family problems; and
8. “Wheeler-dealer” attitude.

Background checks can be an important tool for combating fraud. However, most frauds are committed by first-time offenders, often motivated by desperate circumstances. According to the 2022 report, 83% of the fraud perpetrators had no prior disciplinary record for fraud-related conduct.

For more information, contact Harry Fox at [email protected] or call him at 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.