Inventory best practices

Inventory represents another important area in a lot of organizations. This article provides a list of inventory best practices.

1. A list of inventory best practices

Inventory Reconciliations.  Inventory subledger/detailed records should be reconciled to the general ledger on a periodic basis.  Such reconciliations should be reviewed and approved by a person independent of the reconciliation process.

Minimal Quantity on Hand.  Only keep enough inventory on hand to satisfy your requirements (whether for production, sales, or internal consumption).  Having high inventory stock levels freezes up your cash invested in purchasing and maintaining inventory.  Lower inventory levels will help with inventory turnover and potential obsolescence issues. A word of caution, a sudden need for a large quantity of inventory (for example, for a surprise large customer order) may put your in an unfavorable situation if you can’t source such inventory quickly, so use minimal quantity on hand carefully.

Costing.  If you are using standard costing, you may need to update your standard costs annually or more frequently depending on inventory price fluctuations.  Recall that there is no concept of standard costing for external financial reporting and all inventory balances should be recorded at actual costs or their (close) approximations.  Thus, if you use standard costing, you may need to adjust your inventory balances to approximate actual costs by analyzing and recording purchase price variances (e.g., difference between standard costs and actual costs).

Inventory Counts.  This is one of the most important aspects of managing and accounting for inventory.  Usually, if an inventory balance is material, accounting standards require annual inventory counts.  Consider using bar codes and readers to speed up counts and increase accuracy.

Cycle Counts.  Cycle counts is a form of an inventory physical where inventory items are counted multiple times a year, usually based on certain rules.  For example, all inventory items can be grouped into several categories based on the turnover and value.  High turnover and high value items may be counted more frequently while low turnover and low value items are counted less frequently.  Cycle counts is a great alternative or an addition to annual inventory counts.

Small Immaterial Inventory Items.  These items (like screws, etc.) tend to add work if they are treated as inventory.  For example, production requisitions need to be filled out when they are taken to production; counts need to be performed as part of annual counts or cycle counts.  If the value of such items is not significant and it is in line with your industry practices, consider expensing them when they are acquired instead of recording them as inventory.

Analyze Inventory for Obsolescence.  Regardless of a method utilized to do that, inventory should be analyzed for obsolescence periodically.  If obsolete inventory is identified, it should be reserved for (i.e., a reserve created for the amount of inventory obsolescence). One way to analyze obsolescence is to create reports that show historical consumption of inventory and compare that information to the perpetual inventory balances to determine how much inventory is available on hand (e.g., there are enough units of Part A on hand to last three years).  This can give a clue as to how much obsolescence there is.

Segregate Consigned Inventory.  If your company maintains consigned inventory, it is a best practice to segregate it from your own inventory.  Recall that consigned inventory (e.g., customers’ inventory on your premises) is not recorded on your books, but still needs to be tracked and accounted for.

Use KPIs.  Key performance indicators related to inventory may alarm you about unusual trends or potential issues.  Consider things like these: (a) inventory turnover, (b) inventory aging, (c) inventory reserve rate, and so forth.  There may be specific metrics applicable to your industry.

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