Inventory Audit: How to Design Counting Methods
LAST UPDATE: Feb 25, 2023
8 minutes reading
Most business owners have shivers just from hearing the word “audit.” But knowing the complexities of an inventory audit beforehand will prepare you for what’s to come and set you up for success, regardless of whether the audit is conducted for internal purposes or at the request of an external auditor.
What Is an Inventory Audit?
When you or an auditor performs an inventory audit, you utilize analytical procedures to examine a company’s inventory management practices and ensure that the financial records and the actual count of the products match.
To maintain inventory accuracy, identify reasons for shrinkage, and make sure you always have the proper amount of product at the right time, inventory audits are crucial. Knowing what products, you have on hand thanks to a better grasp of stock movement will also help to guarantee that business operations go smoothly.
History of Inventory Audits
The first inventory audits were performed in 1925 when a man named Phillip Musica who had previously served two prison sentences for robbery took over McKesson, a manufacturer of drugs and medical equipment. Musica hired three of his brothers to create phony sales documentation so that it could extend its actual activities and pay commissions to a shell company they controlled element of the strategy involves fabricating a sizable quantity of crude pharmaceuticals that never existed in order to increase the stock of the shell firm.
It just wasn’t standard procedure at the time, so McKesson’s auditors never questioned the information provided to them or checked that physical inventory in any way.
Eventually, the scam was discovered by the company’s treasurer, the SEC launched an inquiry, and Musica was detained in 1938. The $87 million in assets listed on the company’s balance sheet were ultimately found to be fake, amounting to around $20 million (or $394 million in 2021 currency).
Why Is Inventory Audit Important?
An independent auditor provides an opinion after observing the inventory as part of a generally accepted auditing procedure to determine if the financial records of the inventory accurately reflect the actual inventory being carried.
In particular for manufacturing or retail-based organizations, auditing inventory is a crucial part of acquiring evidence. It could signify a sizable asset or capital balance.
To determine whether the value of the inventory is correctly represented in financial statements and records, an inventory audit must confirm not only the quantity of inventory but also its quality and condition.
How Do You Run an Inventory Audit “Procedures”?
An inventory audit can be carried out in a variety of ways. Here are a few inventory audit techniques to take into account for your online store.
- Completion of a physical inventory count
- Cycle count
- Audit of spot-checked inventory
- Audit of high-value products
- ABC Analysis
- Inventory Reconciliation
Completion of a Physical Inventory Count
The traditional method of verifying your inventory data is to perform a comprehensive physical inventory count. It entails recording every item that is on the shelf.
A cut-off analysis improves the precision of physical auditing. Your company is placed on hold during the count due to a cut-off analysis. However, pausing might be problematic for online stores. During a cut-off analysis, no orders are shipped to customers. To reduce interruption, some eCommerce companies conduct a physical inventory overnight.
A full inventory count doesn’t have to be done all at once. Your auditors will only examine a few products per cycle when using a cycle count. You will eventually have finished an inventory audit of your entire supply. A thorough physical inventory provides you with a snapshot in time that a cycle count does not. It can still offer you the useful information you require, though.
Audit of Spot-Checked Inventory
One or two products are physically counted by your auditors when you conduct a spot-check inventory audit. This gives you a view into any recordkeeping errors by comparing them to your inventory data. Early errors can be detected using a spot-check audit. You can spread out labor-intensive full physical inventory counts by performing routine spot checks.
Audit of High-Value Products
Some e-commerce businesses concentrate their inventory checks on expensive goods. If the calculations are off, these are the products that will cost the most. Thus, they are well investing time and effort in an inventory audit.
The inventory audit can be made simpler by grouping products using an ABC analysis. Your auditors might recommend processes that classify products into cohorts of high- and low-value products.
Products can also be grouped based on sales volume. You can use this method to order your inventory audits. Inventory inspections are probably not as necessary for slower-moving products as they are for faster-moving ones. The ABC analysis also has the advantage of being compatible with warehousing systems. For ease of access during order fulfillment, most companies bundle their best-selling products together. Grouping them for an ABC analysis may be simply due to the location of warehouse shelves.
There may be inconsistencies between your financial records and the inventory audit results. You should then perform an inventory reconciliation. To find the origins and causes of the discrepancies, some investigation may be required.
Inventory Audit Checklist
By periodically conducting your audit, you may see more clearly how your materials are being moved along the supply chain. It can assist you in expense evaluation and external audit preparation.
Planning, execution, and analysis are the three stages of an ideal inventory audit. To assist you in conducting an inventory audit below is a checklist:
Decide which audit items to examine:
Inventory items with a higher risk level should be evaluated more regularly. Prioritize after sorting inventory by SKU or bar code.
Make an audit schedule:
The following step is to create an auditing schedule. Unfortunately, carrying out an inventory audit might impede regular business operations. To guarantee that those high-value goods will be accounted for, you should pick times that have the least negative effects on the business but also occur regularly. The standards and procedures for purchasing and transporting goods could potentially have an impact on the audit’s timetable.
Gather the required paperwork:
Any necessary papers should be prepared in advance and kept in a location that is both accessible and secure.
Conduct the inventory audit:
Depending on the type of your firm, there are a variety of audits that may be necessary. Make sure you have a knowledgeable internal auditor who can complete the audit while being objective.
Note the findings:
It’s crucial to keep track of audit results from year to year or cycle to cycle. The fundamental objective of an audit is to identify compliance gaps and examine ways to close the gap and enhance operational procedures.
Report your findings:
When everything is said and done, you should write a clear audit report that can be used as proof of an external audit is ever conducted.
Common Questions About Inventory Audit
Why is inventory audit difficult?
Conducting an inventory audit can be a very difficult process. And the complexity of the firm increases with its size.
1. It’s time-consuming
Physical inventory audits are quite time-consuming. Consider this: Comparing real inventory levels to the amount of inventory listed on hand electronically or in an inventory sheet for a company selling 500 SKUs can take you days, if not weeks to complete.
2. It’s difficult to measure
The business will need to be more strategic with inventory solutions as they grow. In between complete physical inventory audits, spot-checking may be a more practical approach to keep inventory audits under control. This entails selecting a particular product, calculating the quantity on hand, and contrasting it with the quantity recorded in the system.
3. It can halt operations
Operations, such as order fulfillment and having goods dispatched to customers, stop if everything is put on hold to conduct an inventory audit. In the era of Amazon, satisfying customers expectations regarding prompt delivery might affect how they interact with your offering and how they perceive your company.
What are the two basic inventory issues?
Inventory management is a difficult task. Every area of your business is impacted by the procedure and outcomes.
1. Unreliable tracking
It is time-consuming, redundant, and prone to errors to use manual inventory tracking techniques across various programs and spreadsheets. An integrated central inventory monitoring system with accounting capabilities might be helpful for even small businesses.
2. Warehouse Efficiency
The labor-intensive inventory control procedures at the warehouse include picking, packing, and shipping as well as receiving and putting away. The difficult part is completing all of these things as effectively as you can.
What happens if you fail an inventory audit?
You risk receiving a punishment or worse if you do not appropriately declare the worth of your inventory or transactions. The firm itself must create requirements for the warehouse. Failed inventory audits are not punishable by law, but they can hurt your company’s operations.
You may greatly enhance your inventory systems by conducting routine audits of your inventory. Additionally, inventory management software will make it easier for you to run your business.
To assist with overcoming some of the most difficult inventory management problems, New G Solution provides a suite of native inventory management and control tools. Manage to reorder points automatically, estimate demand, track inventory across different sites, and schedule production and distribution.
If you’re looking to collaborate with an online retailer that has technology and inventory management solutions, check out New G Solution today. Get your free trial today