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Why a Regular Inventory Audit Is Critical to Success

In most manufacturing companies a hands-on, manual inventory audit is taken at least once a year and is therefore referred to as the “annual physical inventory.” Inventory-dependent businesses help maintain the integrity of the inventory by doing what is called a cycle count at least once a quarter. I will talk more about this a little later on. For now, let's consider why it is important to conduct such a tedious, detailed effort.

A very important reason to perform an annual physical inventory is to check if accounting's chart-of-accounts record is accurate and complete for preparation of financial statements and company balance sheets. However, physical inventory is not only an accounting requirement. When the accounting records and the materials requirements planning (MRP) stock-on-hand numbers reflect an accurate in-stock quantity, the business is more likely to run smoothly, profitably, and successfully.

For example, customers will be better served because a part that the computer claims is in stock is actually available to ship as quickly as needed. Verifying inventory counts avoids the delays brought about by costly, last-minute purchasing efforts where a supplier may or may not have the parts in inventory. Maintaining better controls on stock levels means there is also more control of the company's cashflow. MRP will be able to stage orders in the right quantity and at the proper time, avoiding over- or under-stock errors. So the goal of the annual inventory count is to obtain accurate information about inventories on hand, which will help in making the correct, cost-effective business decisions.

As there are advantages presented above, a full physical inventory has its downside as well. They include:

  • Resource hogging.
  • Physical inventory counts are time- and resource-consuming, meaning they are labor intensive.

  • Potential production delays.
  • Inventory audits are more effective when manufacturing, shipping, and receiving activities are stopped or segregated. If not, they can cause production delays and therefore should be factored into the master schedule.

  • Time lags.
  • Physical inventories are usually performed once or twice a year to allow accounting records and MRP levels to be adjusted to match actual physical quantities on hand. At in-between times, there may be differences between accounting records and physical quantities.

An alternative to a full physical inventory count is the inventory cycle count, where the inventory is counted in portions throughout the year. Each company will determine which parts should be counted and how often. A good practice is to rate the parts as A, B, or C inventory. Here is a sample categorization scheme. These cost breaks and terms vary from company to company.

  • A = High Cost > $5.00 per part or item, and/or long lead times (six times a annually)
  • B = Cost > $0.50 and < $5.00 with lead-times less than 2 weeks (three times annually)
  • C = Cost < $0.50 and available immediately (once annually)

There are three phases of a physical inventory count: Planning, Execution, and Analysis

In this blog, I will just list the items in the planning stage. Each company will have different procedures based upon its stockroom arrangements and techniques for inventory control. What follows is a generic list that can be incorporated to provide a basic understanding of the importance of proper preparation for a physical inventory event. In a subsequent blog, I will address the execution of the counting activities and the analysis and disposition of those counts for records management. The items in the planning phase are:

  • a.
  • Prepare a spreadsheet for the count result, part number-description-quantity columns

  • b.
  • Remove all non-inventory product from inventory locations or shelving.

  • c.
  • Make an inventory map of all locations. (Some companies have multiple physical locations for stock to keep bulk level packaging separate from bin levels.)

  • d.
  • Pre-label all shelving with highly visible location numbers on each shelf (if not already labeled).

  • e.
  • Verify that every item on the shelving has a bin and a part number.

  • f.
  • Identify obsolete inventory and remove from active shelving (should be placed in non-net cost stock location).

  • g.
  • Put all part bins in the MRP sequence consistent with spreadsheet list.

  • h.
  • Turn over all empty bins for quick identification.

  • i.
  • Prepare bulk stock location for quantities and sizes that do not fit on bin shelving.

  • j.
  • Prepare inventory tags that will be left in the bins indicating time of count and quantity.

Think of this preparation as similar to clearing a path when you are carrying something heavy from point A to point B. You don't want to be halfway to your destination when you find a boulder blocking your further progress. Not only do you have to find a place to put your heavy burden down, but now you have to remove the obstacle before you can finish your journey. Preparing for a good physical inventory is like measuring the width of a kitchen doorway before buying a refrigerator that won't fit through the opening.

5 comments on “Why a Regular Inventory Audit Is Critical to Success

  1. Barbara Jorgensen
    September 20, 2012

    As tedious as this sounds (I used to work in a retail store where we did this by hand every couple of months) the process also helps identify products that are getting old. I haven't heard a lot lately about old datecodes showing up in the supply chain, but that may be because the datecodes are being changed by counterfeiters. Is it common for manufacturers to discover this dated stuff? If so, do they return it to suppliers, scrap it or resell it?

  2. dalexander
    September 28, 2012

    @Barbara, I know the food retailers will cycle through the dairy and meat products daily. It is usually a manual effort that requires an employee to clear the shelves and make the fresh replacements. This is where a lot of the food kitchen and rescue ministries get their daily food supply. However the drug industry has varying expiration dates and this has to be controlled either by RFID with barcode hybrids or manual as well. I think the longer shelf life products are not as critically cycle counted for expiration as the other, more short-lived drugs. It is a key function built into the Pharma DB to monitor these early expiration products. Usually, these are kept behind the counter and some of the mixtures are not made until the actual time of sale. A suspension comprised of multiple ingredients may be particularly susceptible to a short life time, but when the ingredients are stored separately, they have their own shelf life characteristics. For electronics and date codes, Imy experience is that the distributor will ask me if i can use date codes of such and such and I may have to sign an NCNR – Non cancelable and non returnable, document. If I have to buy from a broker, older date code products are their stock and trade and so they get their parts by part number irrespective of date codes. Franchise distributors may have different arrangements with OEMs for returnable goods and I have no direct experience with this so I would ask others who know how this works to please comment. I know CMs are sources for surplus for many non franchised distributors and i guess the older date code parts can always move in and out of the formal channels via brokers working with CMs and other OEMs that have surplus inventory.

  3. Clairvoyant
    September 28, 2012

    Good article, Douglas. I have known about inventory audits previously, but never really considered all of the different aspects that benefit from doing these audits. Doing audits, even though they take some extra time, helps a company always be prepared to serve the customer in the right amount of time.

  4. itguyphil
    September 28, 2012

    The problem is getting on board to doing them. In most instances, no one wants to because it will be done off-hours.

  5. errricwillson
    November 19, 2013

    We can save more money if we control miscleanous expenses. Your tips regarding to the audit of inventory is the way to create check and balance environment in business.For expample if you want to buy a refrigerator you have number of choices you can buy its with standard , adavnace and special features. But while its comes to money they are clearly can create difference in price. A low price refrigerator in french door style can save you more as compare to old used refrigertor which can increase your budget while it comes to energy. 

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