Companies that stock and sell products and count inventory as an asset, whether raw materials or finished goods, may need a year-end inventory audit. An inventory audit is a physical count of goods in possession or transit. It’s used by the company for internal audit purposes to gain better visibility into their current physical inventory and to ensure the inventory records are accurate. A company’s CPA may require inventory auditing at year-end or another time of year, to confirm an accurate balance sheet or general ledger, so the financial records match the inventory levels.
Inventory accuracy not only allows investors to have faith in the company’s accounting records, but a clean audit report shows the supply chain is operating efficiently. Inventory accounting is a cross-check system on SKUs in stock compared to SKUs on the books.
A physical inventory count can be performed by in-house staff, official auditors, or outsourced to a third-party logistics (3PL) company. Those conducting the inventory process can use barcode scanners or a different system to count inventory, whether the counting procedure is tallying each item or spot-checking.
Importance of Inventory Audits
Now that you know what an inventory audit is, let’s look at why they’re important for your ecommerce business.
They Ensure Inventory Accuracy
The biggest benefit of regular inventory audits is that they give you peace of mind. Your business decisions are often driven by data, and each inventory audit gives you real-time data to plan from.
Here are some elements of your ecommerce business that rely on this data:
- Demand forecasting and planning product lines, marketing campaigns, staffing, and more
- Safety stock you need to have on hand to prevent stockouts
- The ideal reorder point based on product demand
- Store layout and product display
You Can Identify Shrinkage
Shrinkage is what you have when your store has fewer inventory items than are listed in your records. Main causes of inventory shrinkage include shoplifting, employee theft, administrative errors, vendor fraud, and product damage.
If you don’t catch shrinkage on time, you might end up with phantom inventory, or inventory you thought you had on hand, based on your inventory management system.
Noticing shrinkage on time means you can reconcile your records and order new inventory quickly, instead of having an unexpected stockout. It also gives you an opportunity to investigate and solve the causes of shrinkage.
They are Required for Public Companies
Inventory audits are required for public companies if their inventory is classified as a current asset on the company’s balance sheet. For more information about your country’s requirements and auditing standards, search for guidance from financial organizations and experts. In the US, for example, you can find up-to-date information on AICPA, the American Institute of CPAs.
Common Inventory Audit Procedures
There’s no one-size-fits-all approach for conducting an audit. It’s a matter of utilizing the analytical procedure that most appropriately fits your business and inventory needs. Here are some common methods for performing an inventory audit.
A cutoff analysis is when you cut off all receiving and shipping operations to ensure nothing is mistakenly handled or goes unaccounted for when you do the physical inventory count. If you don’t do this, it can throw off your data and lead to a reconciling items investigation.
Physical Inventory Count
To save you the suspense, this is where you physically count your inventory so you know what you have onsite. Ideally, you’ll want to do this with a barcode scanner to record data electronically. If you’re doing this with a professional auditor, they will watch and reconcile your amount with a general ledger to ensure the numbers match.
A cycle count is the process of counting a small group of products at a specific time without having to disrupt business operations. It’s done regularly on a predefined number of products and makes it easy to focus on valuable products and keep their inventory levels accurate.
Freight Cost Analysis
If your business ships products to different locations, this procedure will aid in determining shipping costs. It records when your items were sent and when they arrived at their proper destinations. This also serves as an excellent way to document items that are lost or damaged en route.
Finished Goods Cost Analysis
Although this is an optional procedure, it’s still popular. Overhead costs include utilities like rent and electricity. Analyzing these costs helps you predict the indirect costs of doing business, which can assist you with budgeting for the upcoming year. Again, this procedure is optional and only useful if you count these costs as part of your inventory calculations.
High-Value Item Inventory/ABC Analysis
ABC analysis is an inventory categorization method that groups items based on value:
- A = 20% of stock that represents 80% of your revenue
- B = 30% of stock that represents 15% of your revenue
- C = 50% of stock that represents 5% of your revenue
High-value, rare items are categorized as A items. Medium or mid-value items are sorted as B items. C items are low-value items.
ABC analysis can be an effective method to manage stockrooms. Group C items should be placed by the entrance to quickly speed up trips to the sales floor. Group A items should be properly placed and secured in a safe place to minimize theft and costly losses.
Evidence in Auditing
Evidence is needed to determine whether financial statements or records have been prepared in accordance with standards and free from material error. It is also required to promote the accuracy, transparency, and independence of audit reports.
Evidence is required by auditors to verify the validity of financial records. It can either verify or provide support for the financial information that is presented. On the other hand, the evidence can contradict the financial information, which indicates errors or fraudulent behavior.
Inventory Audit Checklist
To ensure you have all you need for your inventory audit, here’s a quick checklist:
- Conduct the audit around a time when business for your company is slow or not heavily productive
- If using an external auditor, ensure you have all of the required information needed to carry out the audit
- Have a good software that uses real-time asset management, facilitates scanning/tracking of inventory and generates reports
- Move forward with the appropriate procedures (i.e., cutoff analysis, physical inventory count, freight cost analysis, etc.)
- Record and report your findings
- Investigate item discrepancies if any are found in your audit
Although audits vary from company to company, there’s nothing to fear. You now have the right know-how and tools to prepare for your audit and take note of your inventory. Using the ideal inventory audit method or inventory management software for your business increases your efficiency, alleviates stress and helps you successfully meet compliance requirements to ensure smooth operations for your company.
Help with inventory management is one of the many benefits to working with a 3PL. If you are seeking logistics support we’d love to hear from you. You can read DCL’s list of services to learn more, or check out the many companies we work with to ensure great logistics support. Send us a note to connect about how we can help your company grow.