What is inventory?

Many startups and smaller busi­ness­es in par­tic­u­lar find it tricky managing their inventory count on a regular basis, es­pe­cial­ly because it involves a lot of personnel. This is why we will explain exactly what is behind the term and what you have to pay attention to when it comes to your inventory. To ensure that your next inventory count runs as smoothly as possible, we also provide you with tips on how you can carry it out easily and ef­fi­cient­ly.

Inventory counts are not only necessary for tax purposes, but they also help you as the business owner to be able to calculate the value of your own company. However, the act of inventory counting isn’t new: More than 500 years ago, the Italian math­e­mati­cian Luca Pacioli (a good friend of Leonardo DaVinci) rec­og­nized this. His works not only described double-entry ac­count­ing, which Italian merchants used at the time, but also advised the en­tre­pre­neurs of his time to use inventory counts as a core component of the balance sheet.

The inventory count or stock­tak­ing procedure refers to the physical ver­i­fi­ca­tion of the quan­ti­ties in an inventory or warehouse, and what kind of condition they’re in. By carrying out the annual inventory count, you can determine both your assets and your debts. All a company’s assets (and all its debts) should be written down in list form. The purpose of this procedure is to determine the actual inventory. Traders and en­tre­pre­neurs should regularly determine what is in their ware­hous­es with the help of a mer­chan­dise man­age­ment system. Taking an inventory count enables a company to know exactly what stock and assets it has, and how to locate these quickly. It also de­ter­mines whether the inventory you thought you had, is correct. It is not uncommon for the actual inventory to not cor­re­spond to the book balances. Here are five main aims of an inventory count:

A good inventory system can be the dif­fer­ence between a suc­cess­ful company and an un­suc­cess­ful one. Some companies have the potential to make a lot more profit, but don’t achieve this due to operating in­ef­fec­tive­ly. If the company isn’t 100% sure what it has in stock, it might lose sales if there’s not enough of a par­tic­u­lar item in stock and it therefore can’t meet demand. The opposite scenario is also annoying: when you think a certain item is out of stock, but it isn’t. This leads to over-ordering and the customer having to wait longer for no reason. This also means that storage isn’t being used ef­fi­cient­ly, since these “out of stock” items are taking up space without serving as a possible revenue stream. Worst case scenario: the customer will go elsewhere, maybe even to your com­pe­ti­tion.

Companies need to know their assets for tax and op­er­a­tional reasons. Assets can include equipment and stock, for example. If these are taken care of, it means your cash flow statement will be accurate. The rate at which stock and equipment de­pre­ci­ate in value lowers the taxable income of a business, which means the business pays less taxes.

Now you know the reasons that companies perform inventory counts, you now need to decide what you want to count during the stocktake. If you come up with a plan be­fore­hand, it’ll help the process run a lot smoother and quicker. Here are some examples of the cat­e­gories that can be counted:

• Saleable items: Anything being sold to a customer (most popular category to count).
• Main­te­nance items: Items that don’t become part of the end product or are not central to the company’s output.
• Raw materials: These are the component parts that haven’t yet been used in the work-in-process or finished goods pro­duc­tion.
• Furniture, fixtures, & equipment: Noting these down can be valuable in case of damage or theft.
• Rental or movable equipment: Makes it easier to track items moving across locations, even temporary ones for events or field op­er­a­tions.
• Vehicles: Companies should have an idea of how many are in use, which employee is currently making use of them, and where they are.

Some companies only have one location, whereas others have many. No matter how small a location or warehouse, it’s important to carry out an inventory count in every place that’s important to your business. If certain areas are quite large, tackle them in stages so it’s easier to keep an overview. Don’t forget that some of your items might be in transit (i.e. in service trucks or an employee’s car) or on loan. Any products you have that are broken or have been returned should be put to the side so as not to be confused with the current stock.

Choosing when to perform the inventory count can be tricky. During operating hours isn’t rec­om­mend­ed since you might end up with an in­ac­cu­rate result if the process is rushed, and customers will be coming in and buying products as you’re counting them. Therefore, it makes sense to either perform the stocktake after hours, or close the store for a while - but don’t forget to inform customers.

Tra­di­tion­al­ly, physical inventory counts are done with pen and paper and many business owners prefer this tried and tested method. The products are tallied up and then entered into the system. While suc­cess­ful, this method is rel­a­tive­ly in­ef­fi­cient and requires you to enter all the products twice (first on paper, then into the system). Some companies use hand scanners to make light work of the task. These can be rented if you don’t want to purchase them for your company.

Using inventory man­age­ment software, such as that from Vend, you can alleviate the workload and save time.

Estimate how long the count should take so that you can calculate how many staff should be needed. To help you estimate, carry out a “practice test” on a small amount of stock, then multiply that time by the remaining areas that still need to be counted. Work out how many people are needed and then add an ad­di­tion­al person, since you’ll be or­ga­niz­ing people and may not have time to do any of the counting yourself. The helpers should consist of seasoned staff as well as several newer employees who will see things with a fresh set of eyes.

Make sure that each staff member knows the plan, i.e. should they be working left to right, or top to bottom? When an area has been checked, make sure it’s marked off so no-one attempts to do it again. Have a central point in mind so that anyone needing help can go there and have their questions and queries answered. A printout for each helper could be useful if the procedure is starting to get com­pli­cat­ed.

There are three common methods for inventory ac­count­abil­i­ty in the US:

• Weighted-average cost method
• First in, first out (FIFO) method
• Last in, first out (LIFO) method

Generally Accepted Ac­count­ing Prin­ci­ples (GAAP) allows all three methods to be used. Most other countries use the In­ter­na­tion­al Financial Reporting Standards (IFRS), which doesn’t approve of the LIFO method. Another dif­fer­ence between GAAP and IFRS is that they differ on inventory reversal write-downs and costing formulas. With GAAP, the reversal of pre­vi­ous­ly rec­og­nized write-downs is not allowed in sub­se­quent periods whereas under IFRS, a write-down to net re­al­iz­able value is rec­og­nized as an expense in the period in which it occurs.

When eval­u­at­ing your inventory process, you should decide how often you need to carry out an inventory count and which type is the right one for you. The exact reg­u­lar­i­ty of stock­tak­ing differs from one company to the next with some companies choosing monthly inventory counts, and some opting for once a year. This all depends on the company’s inventory turnover and how suc­cess­ful it’s been in the past when it comes to inventory numbers being accurate without a full audit being required. Companies with fewer items don’t need to carry out audits as fre­quent­ly. If bigger companies opt for fully automated inventory systems, they may not require personnel to carry out the stocktake, which saves time and money. Full counts should be carried out at the end of the financial year, although your ac­coun­tant might recommend you do one at your mid-financial-year point. Other rec­om­mend­ed times are before you sell your business and after really busy periods such as holiday weekends or Black Friday sales.

As long as you have a well-com­put­er­ized inventory system, the perpetual counting system (often referred to as “cycle counting”) can save you money as well as increase the accuracy of the count and not disrupt your operation as much while it’s being carried out. Many business owners choose this method since annual physical in­ven­to­ries are a lot more complex and therefore come with a higher chance of errors being made. Because the perpetual method is carried out by software, it makes sense for you to do a few random spot checks (i.e. of high-theft items) through­out the year to make sure the software is giving accurate results. GAAP as well as IRS rules require you to either count your complete inventory on a yearly basis or to implement a perpetual counting system. Cycle counting is es­pe­cial­ly ben­e­fi­cial for retailers since it means the store doesn’t need to be closed while it’s taking place.

This method is quite similar to cycle counting but is slightly more sys­tem­at­ic. Some busi­ness­es choose to perform periodic complete counts every three to six months to check the method’s accuracy. An advantage of opting for this method is that any losses incurred due to theft can be deducted from the tax.

The seasonal method can consist of spot inventory counts or complete counts. The main reason for choosing this is when seasonal trends change or there’s product spoilage. For example, a clothing business might perform an inventory count as the season is coming to an end to make sure it has sold all the stock it planned to sell that season, and to prepare for the next season’s products to be stored in its place. In the food sector, stock needs getting rid of if it hasn’t sold and is near its sell-by-date, as it may violate health codes.

An annual inventory count is common for busi­ness­es that don’t use cycle-counting pro­ce­dures or software, or don’t have many items. Many companies also perform yearly inventory counts in order to rectify any mistakes made in the software, as this loss can go towards tax deduction. An end-of-year-stocktake is carried out to be used in the company’s financial state­ments. Sometimes external auditors are present whose job is to audit the financial state­ments.

The multi­na­tion­al tech­nol­o­gy company, Apple, knows its stuff when it comes to suc­cess­ful inventory man­age­ment. It closely manages its supply chain by trying to keep inventory low, having few ware­hous­es, and letting suppliers fight it out amongst them­selves to work together with the giant.

Keeping inventory level low is es­pe­cial­ly important for companies that sell tech­nol­o­gy since a com­peti­tor might release a new device at any time, meaning nobody is in­ter­est­ed in buying your company’s “outdated” stock.

It’s not cheap to keep moving inventory around and having lots of ware­hous­es. Apple decided to have its suppliers ship their parts to a factory located in China, so that when a buyer orders something, the finished product is shipped directly from the factory, which cuts out several steps and saves time.

Click here for important legal dis­claimers.