Eliminating Annual Physical Inventory Counts

An Article Courtesy of Rush Order, Inc.

In most cases, the answer is "yes". Cycle counts are often a better way to effectively and accurately manage inventory.

Cycle counting is not a new phenomenon. However, there are many common misconceptions regarding how such a process is managed and what benefits may and may not result. Not only can cycle counting provide greater inventory control, larger systemic issues that resulted in discrepancies can be addressed immediately.

Traditionally, full wall to wall physical counts have been the inventory control of choice. Understandably, shutting down operations at the end of each year and counting inventory can be a great way to start the new year with a clean slate.

However, there are several problems with a full annual physical count approach:

• Completely shutting down and subsequently restarting operations is costly.

• Counting inventory during the holiday season is no fun. This may seem trivial but employee morale is a worthy consideration.

• Discrepancies in perpetual versus physical numbers can be very difficult to reconcile. Reviewing and reconciling transactions that occurred during the current quarter is easier than reviewing transactions that occurred over the course of an entire year.

• Discrepancies between perpetual and physical inventory numbers are usually the symptom of a single mistake, or worse, a broken procedure or process. If a system "breaks" in any way after an annual count, it may continue to create unnoticed problems in your inventory all year. It may not be until next year's count that you discover the issue. Not only is this problem costly in terms of misrepresentation of inventory figures, it may be a symptom of a larger issue.

  Example: As in most operations, your accounting system decrements inventory upon exporting a corresponding shipment directive to the warehouse. However, if your warehouse never receives the shipment directive, you now have an inventory discrepancy (perpetual inventory in the accounting system was decremented while physical inventory on the shelf was not). In such an event, you will be forced to react once customers begin complaining about their missing shipments.

  Such events may ruin customer satisfaction levels and increases customer service and accounts receivable costs. Had the problem been uncovered earlier, fewer customers would have been affected.

To mitigate the shortcomings of annual counts, cycle counts can be performed at the beginning or end of each day on a regular basis as part of normal operations. No shut down in operation is required. Each day (or other regularly prescribed basis), a small number of part numbers in the system are counted on the shelf. When a discrepancy is found, the key is to research the root cause and discover the underlying problem that led to the discrepancy.

Note: Simply adjusting the perpetual value in the accounting or warehouse management system without performing in depth research is a lost opportunity to improve the efficiency of your business.

When performed correctly, the primary benefits of cycle counting are realized in two key functions:

• Perpetual inventory is consistently matched to physical inventory on an ongoing basis. As a result, your accounting records are accurate and your marketing team and sales force can confidently deliver on the promises they made to customers.

• With cycle counts, the odds of proactively uncovering and fixing a problem are much higher. In the example given above, you will likely discover the problem in your system or process before it affects a large number of customers.

As a result of these factors, cycle counts typically add substantial benefit to the bottom line.

There are three common approaches to cycle counting:

• Pareto method – Derived from the Pareto Principle (or 80/20 rule), the goal of this method is to set cycle count priorities based on percentages of inventory value. In short, expensive items are counted most frequently and inexpensive items are counted least frequently.

  Example: Using the Pareto method, a merchant selling flat panel LCD televisions may count the televisions twice each quarter while only counting wall mounts once each quarter.

  The Pareto method generally appeals to accountants because it minimizes variances in inventory value. Lower write downs result in higher net income and a healthier balance sheet.

  However, the Pareto method can be inefficient in terms of effectively managing the supply chain. Shortages of inexpensive items can bring the assembly line and/or fulfillment operation to a standstill. In the LCD television example, a shortage of power cords could be catastrophic. Although inexpensive, and thus rarely counted when the Pareto method is used, power cords are an essential component.

• Usage method – The usage method requires that items shipped (or accessed) more frequently should be counted more often, regardless of the item's value. This method purports that the risk of variance is higher every time an employee adds or removes an item from the shelf.

  Although this method is logical in most instances, there may still be reason not to count some high velocity items on a frequent basis. For example, regardless of how often marketing brochures are shipped out, they are probably not worth counting down to the individual unit on a frequent basis.

• Hybrid method – In an attempt to combine the benefits of both the Pareto and usage methods, most companies "score" each inventoried item based on value and frequency of use. The goal is to derive a count schedule based on the relative "importance" of each item. As such, items that are deemed both high value and high frequency are counted more often while items deemed low value and low frequency are counted less often.

  A systematic analysis can be used to score each item, although subjective input from management is often useful as well.

A scorecard method can actually be useful regardless of which of these three methods is implemented. Categorizing each product / item in inventory according to an "ABC" method is often useful. In such an approach, "A" items are counted most often while "C" items are counted least often.

Keep in mind that the most frequent reason for a discrepancy between counts and perpetual values is usually a simple counting error. If you are not scanning each box with inventory scanners, you may be interested in a form Rush Order produced to aid in the counting process. You are welcome to download our count sheet template at your convenience.

Regardless of the method(s) used, cycle counting can be a terrific asset to your business. If you have questions or would like additional assistance setting up a cycle count process for your operation, please feel free to contact us.

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