The Importance of Physical Inventories

One of the least enjoyable aspects of retailing is performing physical inventories. It is a laborious and tedious task that requires extra hours when you and your staff are most tired and irritable. Frankly, it’s about as much fun as brushing your teeth with battery acid! While this overstates the obvious, what isn’t always obvious is that most of the work and burden is not in the actual count itself but in the preparation, audit and analysis of the inventory.

Accurate and timely physical inventories are one of the most important responsibilities in assuring profitability and success for a retailer. An inaccurate inventory can be the difference between profit and loss. Not only can the current year’s performance be misstated, but an inaccurate inventory in one year results in inaccuracy in subsequent years. For example, overstating inventory as the result of a miscount this year will not only overstate profits (and potentially taxes) for the current year, it will show up in the next year when last year’s overage turns into shrinkage. In the meantime, buying and business decisions will have been made based on erroneous information which can have an even more adverse effect on profits.

Essential to the success of any inventory management system is that for proper analytical decisions to be made they must be based upon accurate data. Garbage in; garbage out. It doesn’t take much of an error, for example, if fall suits are counted as spring suits to throw off stock levels and effective buying decisions to assure that the right product mix is available to meet your sales goals for the current and coming season. The implication is even more obvious for basics such as cosmetics. Improper counts not only inaccurately report current earnings, but become the basis upon which future errors and losses will be reported.

Performance, and at least indirectly compensation, of everyone from the executives to the buyers to the sales associates, to the receiving room and administrative staff is affected by a physical inventory. If your staff can trust the accuracy of your inventory control system they will save time. Instead of running to the floor or stock room to check on a product’s availability or performance they need to be confident in the system’s book inventory. All can quickly see that freeing up this time can result in improving controls and accuracy – and even more important – customer service.

As important as accurate counts are to running an effective merchandising system, the acceptable error rate for effective merchandising is much more forgiving than what is acceptable from a financial point of view on a company’s financial statement. Inventory specialists usually find that if your book inventory is within 3% of actual inventory, you have the basis for an effective merchandising system. However, if you turn your inventory twice a year the national inventory shrinkage of about 1.7% (of sales) is more than what is considered ideal for effective merchandising system. The bottom line is that controlling shrinkage and inventory can be the difference between opening another store and closing the doors of a last store. At 1.7% of sales, shrinkage costs the average consumer about $450 a year; that’s over $30 billion dollars a year in the United States alone. The cost is probably two to three times higher for retailers and their staff who bear the brunt of this cost first. However, as independent retailers who remain closer to their inventory, staff, and, most importantly, customers through higher service levels, we should expect much smaller shrinkage numbers as it is much easier for us to control than large, big box operators – who promote high traffic to survive.

While accuracy in physical counts is an important indicator for identifying the source of shrinkage, the timeliness and frequency of physical counts can be even more important. Simply by increasing the frequency of counts, even if cycle counts are added to complete inventories, recent trends or changes are more rapidly identified so appropriate actions can be taken. For example, if a recent hire is dishonest, knowing it in a few months can save thousands of dollars as opposed to identifying it a year later. Legal recourse against one employee who has taken food off the table of the rest of the team is usually impractical.

If you have recently converted to a new inventory management system, or changed your procedures, it is also critical to take timely inventory counts as they provide the ultimate report card on the effectiveness of your procedures, personnel training and system controls.

The first reaction to any physical inventory count that results in numbers outside an acceptable range should be to increase the frequency of counts until the results fall into line. If this simple rule is followed, the implication for not only the importance of careful counts, but the importance of following good day-to-day operating procedures will be much better understood by the whole staff. Haste makes waste, and the best way to reduce the amount of time spent taking a physical count is to make the physical inventory and every transaction of every day as accurate as possible.

As unpleasant and burdensome as physical counts are, they are critical to the success of every independent retailer. While every owner/operator, who has ever seen the effect of shrinkage on a financial statement, is well aware of the importance of accurate and timely physical counts to control shrinkage, it is not as well understood by the people actually recording the counts. Hence, the first step in assuring accuracy in a count is to ensure that all staff members or counters understand just how important a thorough and accurate count is. The first step in planning for every count should be to make sure that everyone understands how important accuracy is and why such an unpleasant experience is so important.

Once the importance of physical counts is understood, proper counting procedures need to be established and documented for a well controlled and supervised physical count. See the article “Procedures for an Effective Physical Inventory” for a discussion of considerations for preparing a physical inventory.