1. Introduction to physical inventory

Companies can generally apply two types of inventory counting procedures:

• Physical inventory (or full physical count or stock-taking)
• Cycle counts (or cycle counting)

Physical inventory is a regular procedure during the operating period which represents a physical count of the entire inventory of a company.

A full physical count is usually performed once a year, closer to the end of the year. A physical inventory is needed to provide accurate accounting data and identify any differences between what is currently in the warehouse(s) and what is reflected in the accounting system. If differences exist, then adjustments should be made to get the accounting counts to match the warehouse counts.

A full physical inventory is usually performed when all inventory movements are stopped to ensure better accuracy.

Cycle counts represent a procedure to validate inventory quantity in the accounting system through regular partial counts.

Cycle count frequency is determined so that every item is counted at least once a year, and a lot of companies perform counts to have all inventory items counted more than once during a year. Cycle counts may be performed on a daily, weekly, etc. basis depending on business needs.

Several methods of selecting inventory for cycle counting exist. One of the methods is to count inventory based on a geographical factor. For example, starting from one location of a warehouse and proceeding systematically to the next location during the year so that by the end of the year the entire warehouse is counted at least once. If a company policy is to count all inventory multiple times a year, then this full cycle of counting a warehouse should take place that number of times, and the number of items counted each time should be adjusted accordingly.

Another method to select counts for cycle counting is to put more emphasis on items with more movement than on items with less movement. This is logical because items which move faster and have higher volume will have more chances of misplacements, etc. resulting in differences between what's in the warehouse and what's in the accounting system. Under this method, an inventory item is assigned to a particular category. Such categories are labeled with letters like A, B, and C (thus, the method is sometimes called the ABC method). For example, category A will include items that turn at least 5 times a year, category B items will include items that turn between 2 and 5 times, and category C items will include items that turn fewer than 2 times a year. Then, the company may decide that any items in category A should be counted 12 times a year, in category B – 4 times a year, and in category C – once a year. Based on this information, the company would select items to count based on the established criteria. An alternative to assigning inventory items to categories would be a combination of how fast items turn and how much they cost.

2. Physical inventory versus cycle counts

There are some advantages and disadvantages in performing cycle counts and full physicals. A lot of companies believe that having cycle counts in place is better than performing a full physical inventory. The reason for this thinking is advantages of cycle counting and disadvantages of a full physical inventory. Let's review them in more detail.

Cycle count advantages:

• Ability to identify and correct inventory recording errors more frequently (e.g. daily)
• Higher inventory quantity accuracy in the accounting system
• Ability to cycle count without interruptions to normal operations
• Fewer employees needed for cycle counting
• Ability to eliminate annual physical inventory

Physical inventory disadvantages:

• Difficult to have accurate inventory quantities in the accounting system throughout the year
• Inventory counters may not be familiar with inventory which may result in recording and counting errors
• Temporary help is usually required to perform a physical inventory
• Overtimes costs may be incurred in order to fulfill a physical inventory
• Operations are usually stopped during a physical inventory

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