A Guide to Conducting Physical Inventory Counts

Date October 25, 2024
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Conducting physical inventory counts is critical for manufacturers. The counting process ensures accurate financial records, which are essential for inventory management. This article defines a physical inventory count, explains why it is important, and offers some best practices on how to properly conduct it.

What is a physical inventory count?

A physical inventory count is the process of counting inventory items to verify the quantity and condition of your on-hand inventory and to ensure the accuracy of the records in the inventory management system. The process typically includes counting raw materials, work-in-progress items, and finished goods.  The primary goal is to reconcile the physical counts with the recorded inventory levels in your inventory management system to identify any discrepancies.

Why are physical inventory counts important?

Physical inventory counts are not just a fundamental internal control practice, they also offer a number of benefits:

  • Accuracy in Financial Reporting: Inventory is a significant asset for manufacturers and discrepancies can lead to incorrect financial statements. Due to its significance, a physical inventory count may be required for financial reporting or tax purposes by investors, creditors, or regulators.
  • Operational Efficiency: Having an accurate picture of your inventory allows for better production planning and scheduling. You can avoid stockouts that disrupt production and ensure you have the right materials on hand to meet customer demands.
  • Reduced Inventory Costs: Physical counts help identify shrinkage, that is, inventory losses due to theft, damage, or obsolescence. By pinpointing discrepancies, you can implement controls to prevent future losses.
What are best practices for conducting a physical inventory count?

There is no one-size-fits-all approach to conducting an effective and efficient physical inventory count. Choosing the best counting process will depend on your business, your inventory, and the processes and controls you have in place. Generally, best practices include:

Preparation

  • Establish a Cadence: Determine how frequently physical inventory counts should be performed. At the minimum a physical inventory count should be performed annually, but monthly, quarterly, or semi-annual counts could be beneficial to reduce discrepancies.
  • Schedule the Count: Choose a time when operations are slow to minimize downtime, typically during a scheduled shutdown or during off-peak hours. Notify all relevant personnel well in advance.
  • Organize the Inventory Area: Ensure the warehouse is clean and organized. Clearly label all items and storage locations. Group similar items together to simplify the counting process. Halt shipping and receiving activities.
  • Assign Roles: Assign specific roles to team members, such as counters, recorders, and data collectors. Assign teams to count specific areas of the warehouse. Ensure everyone is trained in the counting procedures.

Counting Methods

  • Manual Counting: Physically count each item and record the counts on paper or using tags or handheld devices. Mobile weighing scales or pallet jacks equipped with scales can be used to quickly weigh inventory that can’t be manually counted efficiently. While this method is labor-intensive, it is suitable for all types of inventories.
  • Barcode Scanning: Barcode scanners can significantly speed up the counting process and reduce human error. Scanners can instantly update inventory records, providing real-time accuracy.
  • RFID Technology: Radio Frequency Identification (RFID) technology involves tagging inventory items with RFID tags and using RFID readers to count items. This method is fast and accurate, though it requires an initial investment in the technology.
  • Drones and Automation: Drones equipped with cameras and sensors can conduct inventory counts by scanning barcodes or RFID tags or assessing inventories from above. Automated systems can further enhance accuracy and efficiency.

Conducting the Count

  • Double-Check and Recount: For critical items or high-value inventory, conduct a double-check or recount to ensure accuracy. Pair individuals to verify each other’s counts.
  • Record Discrepancies: Immediately record any discrepancies between physical counts and inventory records. Investigate the causes of these discrepancies to address underlying issues.
  • Adjust Records: After completing the count, adjust inventory records to reflect the results of the physical counts. Update the inventory management system with accurate data.

Post-Count Procedures

  • Review Results: Identify patterns or recurring issues, such as frequent discrepancies or damaged goods.
  • Implement Corrective Actions: Based on the analysis, implement corrective actions to prevent future discrepancies. This may include improving storage practices, enhancing security, or updating inventory management procedures or controls.
  • Report Findings: Prepare a detailed report of the inventory count results, including any discrepancies, their causes, and the corrective actions taken.

Physical inventory counts are a vital component of any manufacturing operation. Apply the practices that best suit your organization’s needs and capabilities. By following these best practices, you can ensure accurate inventory records and financial accuracy, and improve overall operational efficiency. 

To discuss physical inventory counts and inventory management for your company, contact a member of HBK Manufacturing Solutions at 330-758-8613 or manufacturing@hbkcpa.com.

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