What is a Physical Inventory Count and Why is it Important?

Last Updated: October 25, 2024

Physical inventory counts are a vital part of any successful ecommerce business, as they provide you with an accurate account of what is actually in stock. All too often, businesses rely on their inventory management systems to give them an accurate count of what they have in stock, but this isn’t always the case. Physical counts are a way to verify that the inventory system and the actual stock are in agreement.

The main goal of a physical inventory count is syncing the number of items physically in stock with the number in your inventory management system. This process can be a time consuming task, depending on the size of the business and the amount of items in stock. Many businesses choose to hire outside employees to help with the physical counting process, as it can be challenging to perform while simultaneously maintaining fluid fulfillment operations.

Why is Physical Inventory Counting Important?

The benefits of performing a physical inventory count are numerous. Fundamentally it provides your business with an accurate count of what is in stock, which helps ensure that there are no discrepancies between the inventory system and the actual stock. Other benefits include:

• Reduce stockouts
• Limit lost profits due to incorrect stock levels
• Identify discrepancies between the inventory system and actual stock
• Diagnose reoccurring inventory issues
• Reduce inventory waste
• Lower the number of missing SKUs

Physical inventory counts can be done by implementing systems and processes that track inventory levels in real time and use automation to manage the flow of inventory throughout the supply chain, from warehouse receiving to returns management.

Purpose of a Physical Inventory Count

A physical inventory can ensure an accurate inventory tally. Staff physically count each piece of stock. This physical inspection of goods should confirm what’s in the inventory management system report. Any discrepancy should alert you there’s another issue.

Businesses perform physical inventories for other reasons, such as when preparing a balance sheet for tax season. Additional objectives of an inventory count include:

• Check and Balance Inventory Levels: Physical inventories can help managers see any discrepancies between their inventory management system reports and what items are in their storage.
• Manage or Monitor Theft: The difference between what appears in the inventory management system, and what is present can be due to missing, stolen, lost or broken items. Unless staff manually enter when these scenarios occur, the system would not recognize them.
• Create an Accurate Budget: Companies with precise inventory counts can better plan their budget for the next year’s inventory orders.
• Report Accurate Earnings: An inaccurate inventory means a company will report an incorrect amount for the cost of goods sold, the gross profit and net income. Public companies are primarily accountable to their stakeholders to provide correct figures in their annual reporting.

How Do You Perform a Physical Inventory Count?

The inventory count is one of the most important steps for an ecommerce business. It is a process that’s crucial to making sure your company can supply its customers with what they need and when they need it. It involves inspecting each item for quality and quantity, ensuring you have what you need on hand. So, how can one carry this process?

Here are a few steps that you must follow to count inventory:

1. Order Count Tags – Order enough two-part count tags to cover the amount of inventory that will be counted. These tags should be numbered sequentially so that they may be tracked individually during the counting process.
2. Review Inventory – The fulfillment center workers should be notified if part numbers are missing or items look to be in a condition that would make counting difficult. This will allow them to make any necessary changes for the upcoming inventory count.
3. Pre-Count Inventory – Pre-count any products that can be stored in sealed containers. Seal them in the containers and label them with the quantity. This simplifies the counting process during the actual count. If a seal is broken, a counting team will know that the contents of a container must be counted again.
4. Complete Data Entry – If any data entry transactions need to be performed before the physical inventory count, do so now. This comprises issuances from the warehouse, returns to the warehouse, and transfers within the warehouse between bin locations.
5. Notify Outside Storage Locations – Notify any outside storage facilities or third-party sites where company merchandise is held on consignment that they must count their inventory on hand as of the official count date and forward this information to the warehouse manager.
6. Freeze Warehouse Activities – Stop all deliveries from the warehouse and put any freshly obtained goods in a separate area where they won’t be counted. Otherwise, during the inventory count, the inventory records will be in a state of flux and hence will not be completely reliable.
7. Instruct Count Teams – Assemble two-person teams to count the inventory and train them on how to do so. These responsibilities entail having one person count inventory while the other records the data on a count tag. One copy of the tag is attached to the inventory, and the other copy is kept by the team.
8. Issue Tags – The count teams are given blocks of count tags by an inventory clerk. Whether or not the tags are used, each team is accountable for returning a certain numeric range of count tags. Maintaining control over all count tags means that any missing tags are quickly investigated.
9. Assign Count Areas – Each count team should be given a defined range of bins to work with. Make a note of these locations on a warehouse map with a highlighter. The inventory clerk should keep track of which parts of the warehouse have been counted and whose teams have been assigned to each area on a master list.
10. Count Inventory – Each team must have one person counting a specific item within a bin location, and the other team member recording the bin location, item description, part number, quantity, and unit of measure on a count tag. The team must then keep the original copy of the tag and attach it to the inventory item.
11. Verify Tags – Ensure that all tags have been returned on completion of the inventory count. Assign a new area to the count teams and issue them fresh blocks of count tags as needed if there are more warehouse locations to be counted.
12. Enter Tag Information – Fill out an online data entry form with the information from the count tags. Print a report showing all tag numbers input, ordered by tag number, and look at number discrepancies, if any. This will verify that the file contains all of the count tags that were issued.
13. Investigate Unusual Results – Re-sort the inventory report in a few different ways to locate unusual data, and check the tag entry connected with each inventory.
14. Use Inventory Management Software – Completing an accurate physical inventory count takes a substantial amount of time and effort. This is one of the reasons why organizations limit the number of counts they perform each year. However, inventory management software, such as DCL’s eFactory, can assist you in expediting this process while maintaining accuracy. Inventory software can assist you in reducing workload and saving time.

Additional Ways to Improve Physical Inventory Counting

Here are several best practices for taking physical inventory that we have found effective in inventory count processes.

1. Establish a Comprehensive Inventory Department

Small to moderate sized fulfillment centers may not have this function. Responsibilities include: cycle counting, correcting warehouse back orders as they occur, implementing continuous improvement, bin managements, etc.

The inventory department should be charged with identifying and implementing ways to keep the inventory accuracy high and to eliminate the manual paperwork; correcting warehouse back orders, reconciling systems and physical causes of inventory shrinkage.

2. Implement Inventory Cycle Counting

If you don’t already use cycle counting, make it a priority to understand what capabilities your warehouse management system has and set it as a process improvement objective. There are different types of inventory counts, including cycle counts for locations that hit zero to ensure accuracy, or counts when the wrong item is discovered.

3. Secure High Value or High Shrink Inventory Items

It may be best to identify high value or high shrink products that might be apt to be stolen. Set up caged or locked areas with restricted access. Some high value categories may require a physical inventory daily because of value (e.g. fine jewelry).

4. Use Barcode Reading Technology

Many businesses still use manual count sheets to manually record the count. Save time and reduce human error by implementing barcode scanning for inventory counts. Software is also available that can turn smartphones and tablets into scanning devices for physical inventory counting.

5. Implement an Inventory System Audit Trail

Newer warehouse management (WMS) and ERP systems generally offer inventory tracking in two ways:

• By bin/slot location and what SKUs have moved in and out over time
• By SKUs and all the bin/slot locations it has moved in and out.

This occurs in real time and is archived as long as needed.

The tracking is by transaction type: sales, receipts, returns, inventory adjustments, etc.  It also identifies the associate who processed the transaction with the transaction number, date and time stamp. Older systems may not have this capability.

What are the Different Types of Inventory Counts?

There are four types of inventory counting: full counting, cycle counting, tag counting, and ad hoc counting. 

• Full counts are a total review of all products in a warehouse or store. This includes goods on warehouse shelves, product shelves, products currently being stocked, and everything in between. 
• Cycle counting is counting all the products in a designated area of the store, or a particular type of product. You then move from one zone to the next until the entire store is counted within a time period. Cycle counts are most effective in high traffic industries, like grocery and retail. 
• Tag counting is the same as an inventory cycle count or full count, simply with tags assigned to products. Counters add product info to each tag, and at the end of the count, staff checks the tag information against system data. 
• Ad hoc counting is used on the fly for areas of concern, or products that are going to be updated soon. With this method, employees count whichever items they’re assigned and update the inventory data in their warehouse management system. 

Bottom Line

Overall, physical inventory counts are a great way for businesses to ensure that their inventory system and actual stock are in agreement. It can help to reduce the amount of lost profits, theft, and out of stock items that customers experience. It can also help to identify any items that need to be replenished or replaced. Physical inventory counts can help to ensure that businesses always have an accurate account of what is in stock, which can help to improve customer satisfaction.

Tags: warehouse management