Inventory Audits: How to Create Counting Procedures

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They might be nobody’s favourite thing, but audits play a big role in your business’s growth. They help you manage inventory with less waste and understand where things are and aren’t working. Whether it’s for internal purposes or at the request of an external auditor, once you understand the nuances of an inventory audit, you can prepare effectively and run them well. Right now, that probably doesn’t change the fact just seeing the word “audit” sends shivers down your spine. But it’s time to get comfortable and confident with this beneficial and necessary process.

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What is an inventory audit?

An inventory audit is the process of checking a company’s inventory methods, and confirming that financial records and the actual count of goods match. They can be run internally by you and your team, by in-house auditors from your parent company (if you work as part of a franchise) or by an external auditing company.

It’s important to conduct inventory audits to maintain exact quantities of stock and raw materials, and to spot causes of shrinkage. A better understanding of the products you have stocked, when they’re moving and in what quantities is crucial to cost-saving and planning. It ensures that there are no issues with the way you store and handle stock, and that no theft is taking place.

Audit procedures for inventory

During an inventory audit, records are validated through a number of checks. You, your staff or the external auditor manages thes, and they include:

  • Inspection: checks your internal records and documentation. For example, to make sure stock sheets have been signed by the recipient.
  • Observation: checks the inventory management processes carried out by your team.
  • Confirmation: checks audit evidence sent directly from a third party.
  • Recalculation: checks the mathematical accuracy of documents or records.
  • Performance: where someone else (an employee or auditor) carries out the procedures or checks controls that you have in place.
  • Analytical analysis: checks financial information via various data points.

To give you a clearer idea of what’s involved, here’s a list of some inventory auditing procedures that can be run in your small business:

  • Physical inventory counting.
    This is the process of counting each item of inventory so everything is accounted for. It’s a manual and often time-consuming task, which is why many business owners schedule it ahead of time to avoid disruption. Barcode scanners or a simple clicker counter can be used to help you keep track more easily. If you’re working with an auditor, they’ll probably want to observe and reconcile the count with your general ledger.

  • Inventory layers.
    If you manage inventory using the FIFO (first in, first out) or LIFO (last in, first out) systems, check the layers of inventory you’ve recorded to make sure they’re right.

  • High-value item inventory analysis.
    You can categorise stock into value levels through ABC Analysis. This technique helps you focus on the few critical items rather than just getting lost in the many smaller ones. ABC analysis can also help you manage your stockroom better. Fast moving items in Group C can be stocked near the entrance to speed up trips from the sales floor. And slow moving, high value items in Group A can be safely secured at the back to reduce the chance of theft. Auditors themselves are likely to spend extra time counting high value items.

  • Inventory in-transit analysis.
    This inventory audit tracks the time between the date of shipment and the date of receipt when products are moving between locations. It helps reduce the risk of things getting lost or damaged in transit. Auditors will test your transit processes by looking at transfer documents.

  • Shipping cost analysis.
    This analysis works out shipping costs, i.e. how much it costs to get products from one place to another.

  • Finished goods cost analysis.
    This is used if you make your own products. When all production on the inventory item is done, it becomes a “finished good” that’s ready to be sold.

  • Overhead analysis.
    “Overhead” is the cost of doing business excluding direct materials and labour, like rent or utility bills. An overhead analysis predicts the indirect cost of doing business, helping you budget for the year. If you don’t include overhead in your inventory, there’s no need to run this.

  • Reconciling items investigation.
    There will often be discrepancies between inventory counts in your company’s records and the actual amount of stock on shelves. Discrepancies should always be investigated to figure out why they happened and to amend your records accordingly.

  • Test invoices listed in receivable report.
    Invoices are selected at random, then compared to relevant documents to see if they were billed in the correct amounts, to the right customers and on the correct dates.

  • Match invoices to shipping log.
    This verifies that invoices for items line-up with what’s left and the cost of what was shipped from your warehouse or store.

  • Cash receipts review.
    This process counts and balances all receipts for items paid for in cash.

An inventory audit checklist

Inventory audits help you see how materials are moving through the supply chain, evaluate costs and prepare for future external audit procedures. It’s just good business housekeeping.

The most useful and effective inventory audits use planning, execution and analysis. So you can start running your own, here’s a checklist of what to do:

  1. Decide which items to audit.
  2. Create an audit schedule.
  3. Gather up all the relevant documentation.
  4. Conduct the inventory audit according to what’s most important to your business.
  5. Record what’s working, what’s going badly and how you intend to scale and improve your processes.
  6. Report on your findings in a succinct audit report (this will help down the line if and when an external audit is ever conducted).

Using inventory management systems

An efficient inventory management system can reduce the length and complexity of audits. For example, a system that tracks and scans items when they enter or leave your store removes the need for clumsy, manual tracking work, keeping your records accurate.

Square Point Of Sale comes with its own inventory management system to help you track items anywhere and at any time. Simply import your product spreadsheet into the inventory management system, customise names, manage quantities and edit prices all in one place. You can also set up stock alerts that notify you when inventory reaches a certain count. This creates a clockwork process for managing stock and reacting quickly to sudden changes in demand.

Given that small businesses have to pay attention to every penny, an inventory management system can make all the difference. Integrated, digital systems are easy to set up and use, and remove a lot of the hard work you’d have to do otherwise.

Whilst running your own independent audits, they provide peace of mind that you’re seeing the numbers as they really are. And when you’re established enough to receive an external audit, you’ll be ready.

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