Physical inventory and how to account for it

Most people don’t realize how expensive it can be to run an inventory-based business. And with a bad inventory system in place, a company can (and most likely will) lose sales.

Proper measurement of inventory is a critical element for a business to able to interpret and understand their profit margins. Find out why it’s important for your company to perform regular physical inventory counts and how to account for it.

Companies should always use a system to track inventory rather than an Excel spreadsheet, so if your company is relying on Excel to track your inventory, it’s time to reconsider. Using an Excel spreadsheet can be risky for a couple of reasons:

1) The spreadsheet can crash and cause you to lose data

2) The spreadsheet can get lost

3) General human error caused by manual data input

While a system can crash as well, the possibility of it happening is far less likely than when using Excel.

What is a system? A system can be anything from accounting software (like Netsuite), a CRM, or a thirty-party system like a 3PL (third-party logistics)- a warehouse that tracks your inventory for you. There are also systems like SOS Inventory or Stitch Labs which can integrate with your accounting software.

Whichever system your company has in place, it’s important to also have some sort of manual controls; e.g., someone who can do a physical count.

What are the best systems to track inventory?

The best inventory software to use for your business varies on what you’re looking for and what kind of inventory you have. For example, if you have a really basic item, like you sell widgets, you don’t need to make it more complex than it is. But if you’re building items, like furniture, you will want to consider a slightly more complex system because there are a lot more components that come together. Netsuite, SOS Inventory, and Stitch Labs can do that.

Which channels your company is selling through can also determine which inventory system your company chooses to use. For example, most retail businesses sell both online and in store and will want to choose a system with multichannel integration. Large inventory-based companies will generally spend a lot of money to build their own custom inventory systems.

Who should be responsible for tracking physical inventory?

The size of your company generally determines who should be responsible for tracking physical inventory. Large companies should have an Inventory Manager or someone who manages the warehouse full-time. For small and midsize companies, the responsibility could fall on the company’s operations team to decide who is best skilled to track inventory. This person may be responsible for doing the physical count or answering general questions about what is going on with the inventory. Another option, albeit costly, is to hire a 3PL (ex: a third-party logistics warehouse) to manage your inventory for you.

How often should a company do a physical count?

Regardless of the size of your company, what your company does, or what industry you are in, physical inventory counts are recommended on quarterly basis. However, if your company is in a state of flux (e.g. your business is just starting up) or there are a lot of issues in your system, you may want to do more regular physical counts and perform them monthly or even weekly.

For a company doing counts weekly, they would want to establish procedures. For example, take a box and weigh it; how much does it weigh? If you add a single widget into the box, the difference will give you the weight of each widget. You can then toss any number of widgets into the box, subtract the weight of the box, and then divide by the weight- you can easily determine how many widgets are in the box.

Which costing method is best for your business?

Since costing methods are not one-size-fits-all, here are the four main costing methods and which each best fit:

LIFO (Last-In, First-Out)

The LIFO costing method means the newest item in the door is the first item out. This method is used by companies who want to generate less profit and reduce their taxable income.

FIFO (First-In, First-Out)

FIFO costing method assigns costs to a company’s inventory, valuing the inventory at the end of year by assuming the first items purchased were the first sold. For example businesses whose inventory consists of spoilage (e.g. perishable goods), the first items through the door should be the first items out the door.

Specific Identification

The specific identification costing method is simple and accurate, but is rarely used due to the amount of time and effort it takes a company to scan and enter each piece of inventory into the system. For example, Rolls-Royce may use this costing method to value its inventory since every vehicle is customized and unique to its owner.

Weight Average

The weight average costing method assigns the average cost of production to a product. This method is commonly used by companies whose inventory items are identical to each other or where items are mixed together and it’s impossible to assign specific costs to individual units.

 

Signature Analytics will not only help guide your company through the inventory process, but can ensure that your business is using the right costing method and tracking systems. Contact us today for a free consultation.