Poor inventory management practices can cost your business time and resources. Research shows that $1.1 trillion (about 7% of the US GDP) is tied up in inventory, accounts receivable, and accounts payable.
If that statistic makes you take a second look at your inventory management practices, you're not alone. 46% of SMBs either don’t practice inventory auditing or use a manual method. Having effective inventory management practices not only facilitates smoother and quicker audits but also enables ecommerce businesses to scale at will.
We’ll show you 10 inventory auditing procedures to turn audits from a chore into a game-changer for your business.
An inventory audit – often referred to as a stock audit – is a crucial business process that meticulously examines a company's inventory data for accuracy.
It verifies that the physical inventory count of goods matches the recorded quantity in your accounting system and your accounting records, ensuring that your inventory is accurately represented in your financial statements.
The process typically involves counting items, checking for discrepancies, and reconciling any differences. This is not just about number crunching; it's about ensuring the integrity of your financial records and identifying inefficiencies in your supply chain.
An inventory audit can reveal issues like shrinkage, theft, spoilage, or problems with purchasing procedures, serving as a valuable tool for improving overall inventory management. It’s also a requirement for businesses under GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards).
10 vital inventory audit procedures to follow
Follow these top 10 procedures for a more efficient process:
Physical inventory count
This is a physical count of all inventory items, usually conducted at fiscal year-end. Accuracy is vital for a physical inventory count as discrepancies might indicate problems such as theft, spoilage, or record errors.
Research by the National Retail Foundation shows that shrinkage – due to theft, fraud, and inventory management errors – cost US retailers nearly $61.7 billion in 2019. To improve accuracy, consider separating counters and recorders, and using standardized counting procedures. An accurate physical inventory count helps verify your inventory data, which corrects potential issues and ensures smooth business operations.
Cycle counting is a frequent, systematic count of different areas of inventory in rotation. This method enables ongoing validation of inventory systems and minimizes operational disruption compared to full-scale physical inventory counts.
A study by Auburn University showed that businesses that engaged in cycle counting saw a 65% reduction in inventory discrepancies.
Regular cycle counts can identify issues earlier and allow businesses to address them proactively, improving inventory accuracy over time. With cycle counting, businesses can maintain higher customer satisfaction levels due to fewer out-of-stock situations.
Cut-off analysis aims to ensure that transactions are recorded in the correct accounting period. It involves auditors ensuring that no inventory leaves or is received in the warehouse during the auditing period. For instance, inventory purchased in December must be included in December's inventory, not January's.
This process is crucial for maintaining accurate financial statements. Ensuring that sales, purchases, and returns are recorded in the right periods maintains the integrity of inventory valuations, supports correct financial records, and helps to avoid over/understated profits.
ABC analysis is a tiered inventory auditing approach that segments inventory into three categories based on importance and value. ‘A’ items are high-value with low quantity, ‘B’ items are medium value and quantity, and ‘C’ items are low-value but high quantity.
ABC analysis helps you allocate resources efficiently during an audit. It shows businesses which items need more stringent controls, balancing cost-effectiveness and risk management.
Sample-based inventory audit
If auditing your entire inventory isn’t practical, a sample-based inventory audit can be helpful. This involves checking a random selection of inventory for accuracy and extrapolating the results to infer the total inventory.
Though it's less precise than full inventory counts, this approach is a quicker, less expensive way to regularly validate your inventory management system.
Freight cost analysis
Freight cost analysis involves evaluating shipping costs, a significant part of inventory carrying costs. This analysis helps businesses accurately account for all inventory costs and any related expenses.
Freight cost analysis can also unveil opportunities to negotiate better freight rates, and shipping costs or highlight areas where supply chain logistics could be optimized, potentially reducing costs and improving delivery times.
Finished goods cost analysis
Finished goods cost analysis is the process that verifies that the recorded costs of produced goods are accurate. It considers direct materials, direct labor, and manufacturing overheads.
By ensuring that your finished goods' costing is accurate, you can set appropriate sales prices, calculate profitability accurately, and make informed decisions about production, pricing, and sales strategies.
We've looked at finished goods cost analysis, now let's look at overhead analysis. This involves auditing the indirect costs tied to producing your goods, such as utilities, rent, and equipment depreciation. Correctly allocating these costs to your inventory is crucial for accurate financial reporting.
Overhead analysis ensures you're not underestimating the total cost of your inventory, which could lead to misstated profit margins and uninformed business decisions.
Inventory count reconciliation
Reconciliation involves matching the physical inventory count of to recorded figures. During the process, be sure to investigate and correct any discrepancies you discover.
Regular reconciliations help to maintain data accuracy, identify patterns in shrinkage or errors, and can be instrumental in improving overall inventory control.
Other analytical procedures
In addition to common inventory audit procedures, businesses can use other analytical procedures.
For instance, comparing the inventory turnover ratio with previous years can highlight changes or trends.
A sudden change in turnover might indicate potential issues like overstocking or dwindling sales, providing valuable insights for inventory management strategies and financial performance improvement.
How to conduct an inventory audit in 3 steps
We’ve covered some of the key audit procedures for inventory. Now let's see how you can put those procedures into practice.
Step 1: Preparing for inventory auditing
Here’s how to prepare for an inventory audit:
Organize your inventory and workspace
Before you start an inventory audit, your inventory, and workspace should be well-organized. This makes it easier to audit accurately and reduces the chances of miscounts.
Similarly, digital inventory for ecommerce stores should be meticulously organized, with all items correctly listed and categorized.
Review and reconcile inventory records
Reconcile inventory counts from different sources, such as physical counts, digital records, and purchase/ sales invoices, and fix any inaccuracies. Regular reconciliation can catch errors early, smoothens the audit process, and reduces large-scale discrepancies. Using a software solution like Linnworks makes this task easier by flagging inconsistencies and helping you rectify them quickly.
Set clear audit objectives and goals
Setting clear audit objectives can steer the entire audit process, making it more focused and effective. Whether you want to validate the accuracy of inventory records, identify shrinkage sources, or enhance cost efficiency, having clear goals will help you choose suitable audit methods and interpret audit results accurately.
Train your team or coordinate with external auditors
If you're conducting an in-house audit, your team needs to understand the audit procedures, standards, and goals thoroughly. Conversely, if you're hiring external auditors, proper coordination is vital.
In both cases, Linnworks can streamline the process by providing intuitive access, resources, and crucial information to ensure that everyone is up to speed.
Schedule the audit to minimize disruption to daily operations
Inventory audits, especially a full-scale physical inventory count, can disrupt normal operations. To avoid this, schedule inventory audits during less busy periods, or during off-hours.
For continuous audit methods like cycle counting, integrate the inventory audits into your daily operations. This is where Linnworks shines, enabling smooth scheduling woven into your business's daily rhythm to minimize disruption and keep you bringing in sales simultaneously.
Step 2: Conducting the inventory audit
Once your preparations are complete, follow these steps to conduct your inventory audits:
Establish a systematic counting process
Kickstart inventory audits by establishing a systematic counting process. Assign specific responsibilities to teams, preferably mixing individuals familiar and unfamiliar with the inventory for an unbiased view. Develop user-friendly counting sheets, or better yet, use inventory management software like Linnworks to automate this process and eliminate human error.
Finally, implement a clear system for marking counted items, preventing double counting or overlooked items. Linnworks makes it easy to track the progress of counted items in real time.
Execute the count
Once the counting process is established, begin the physical count. Count each item and record the quantity on your counting sheets or directly into your inventory management software.
For larger inventories or high-value items, consider double-checking counts for accuracy, which could involve recounting a certain percentage of items or having a second team independently verify the counts.
Make sure all items are accounted for, not overlooking any damaged or obsolete stock, as these can affect the overall value of your inventory.
Reconcile the count with inventory records
After the physical count, reconcile the numbers with your existing inventory records. This involves comparing the physical count results with your recorded data and investigating any possible discrepancies.
Potential causes could range from clerical errors to theft or loss of items. It's vital to document these discrepancies, noting their cause and resolution. After investigation, make necessary adjustments to your inventory records, which could mean writing off lost items or correcting data entry errors.
Using Linnworks streamlines your reconciliation process, enabling efficient and accurate adjustments in your records.
Carefully review documented differences and try to identify any patterns or trends. Are there discrepancies recurring in specific categories, locations, or times? Maybe a particular product often shows a variance or a certain storage area frequently reports missing items.
By identifying such patterns, you can pinpoint problem areas that need further investigation, which might reveal underlying issues such as theft, systemic errors, or supplier problems.
Evaluate the effectiveness of the audit process
Ask critical questions like: How accurate was the initial count? Were there any hurdles during the reconciliation process? How well did the inventory management software perform? Was the assigned team adequately trained and effective?
This evaluation helps you understand the strengths and weaknesses of your audit process. It also shows you which areas worked well and which ones need to be improved for future audits.
Develop action plans to address issues or improve future audits
Create targeted strategies for recurring discrepancies. This could involve steps like heightened surveillance, improved data entry procedures, or additional training for staff handling these items.
If you discovered weaknesses in your audit process find ways to enhance it for future audits. For example, consider investing in an advanced inventory management system like Linnworks that can streamline your audit process, ensuring accuracy and efficiency. You may also decide to provide more comprehensive training for your team or tweak the timing or frequency of your audits.
Inventory audit procedures best practices
To ensure a seamless inventory audit process, there are three key best practices to adhere to.
Establish a regular audit schedule: Don't leave audits to chance or crisis moments. Implement a regular schedule, be it annually, quarterly, or even monthly, based on your business size and inventory turnover. Regular audits help catch discrepancies early and keep your inventory data reliable and up-to-date.
Use technology to streamline the audit process: Tools like Linnworks can significantly ease your audit process. With automated tracking, real-time updates, and comprehensive reporting, the software reduces manual errors and saves time, enabling a more accurate and efficient audit. What’s more, cloud-based inventory management software means you can accommodate growing customer needs.
Continuously train your team: Ensure your team is well-versed in inventory audit procedures. Regular training sessions, updates on new software features, and workshops on best practices keep everyone aligned and competent, leading to more effective audits.
Remember, a well-orchestrated inventory audit can provide invaluable insights into your operations, ultimately supporting better business decisions and enhancing your profitability. By adhering to these best practices, you're well on your way to making the most of your inventory audits.
Maximize efficiency and accuracy with the right inventory management software
Inventory audits are not just a necessity, but a game-changer for your ecommerce business. They provide critical insights for efficient inventory management, making the process simpler and more accurate.
Inventory management software like Linnworks is a must-have tool in your arsenal. With features like real-time inventory tracking, automated order management, and comprehensive reporting, Linnworks takes the guesswork out of your audits and lets you focus on driving growth.
Take control of your inventory audits today, reduce discrepancies, and maximize profitability. Turn your audits from a daunting task to an empowering business function – take a Linnworks tour today.