Physical inventory procedures

September 10, 2009

Physical inventory and purposes; three phases: planning and preparation, execution, and analysis of results; methods of conducting physical inventory such as bar-code readers, count cards, and count sheets.

1. Goals and reasons for conducting physical inventories

There is one day in the year when you and/or a group of your employees go to the warehouses and attentively count (quantity, weight, etc.) and record every item (goods, materials, supplies, etc.) there. Then any differences are investigated and necessary adjustments are made. You probably agree that this is an expensive, hard and not very pleasant, but very necessary process – an annual physical inventory.  So let’s consider why it is important to conduct a physical inventory.

The most obvious reason is that you conduct a physical inventory to check if the inventory accounting records are accurate and complete at a particular time (every item found in the warehouses is recorded and every recorded item is found in the accounting records). However, physical inventory is not only an accounting requirement. When your accounting records show an accurate stock quantity, your business is more likely to be profitable and successful as a whole. Customer relations will be good because you can quickly ship required quantity of products to them. You will also have better control of your stock levels and company’s money; you will be able to order the goods in the right quantity at the proper time avoiding over- or understock. So the goal of the annual inventory count is to obtain accurate information about inventories on hand, which will help you to make right business decision.

As there are advantages presented above, a full physical inventory has its disadvantages:

  • Physical inventories may be time and resource consuming (e.g. personnel costs).
  • Physical inventories are more effective when manufacturing, shipping and receiving activities are stopped, which again brings in the cost factor (e.g. lost production).
  • Physical inventories are usually performed one or several times a year (normally once) and thus, accounting records are adjusted to match actual quantities on hand just a few times during a year.  All other time, there may be differences between accounting records and physical quantities.

An alternative to a full physical inventory when all inventory is counted at a point in time is  inventory cycle counts when you count inventory in portions throughout a year.  Cycle counts will be covered in greater detail in another article.

There are three phases of a physical inventory:

  1. Planning and preparation
  2. Execution
  3. Analysis of results
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