Best Practices in Physical Inventory and Cycle Counting Processes

One of the key aspects of inventory management and control is maintaining accurate records of inventory on shop floor and in warehouses. Accuracy of inventory data is one of the pre-requisites for an efficient supply chain. Without accurate inventory information, none of the activities within the supply chain can be efficient. Customer shipments would be missed because actual inventory would not be available to ship orders. Procurement would be sub-optimal because material would be ordered even when sufficient material is available. Assembly lines might shut down due to non-availability of key components, although systems would suggest adequate raw materials are available. Supply Chain planning would become ineffective due to “garbage in, garbage out” conditions. There can even be legal implications of showing incorrect inventory on financial statements. If such conditions continue for a long time, employees would lose their trust in systems, causing business processes to collapse. These are only some of the risks not having accurate inventory data.

Anyone who has worked in Supply Chain domain would have first hand experience of myriad of problems arising due to inventory inaccuracy. In my experience, I have seen several supply chain projects delayed for months or even failing altogether because of the inability of organizations to fix issues in their inventory data.

Importance of Physical Inventory and Cycle Counting processes

Maintaining accurate inventory data requires strong processes in all facilities to ensure that all the inventory transactions are correctly recorded in the systems. Despite the most disciplined efforts to ensure system accuracy, inventory records can frequently go out of sync with the actual inventory on the shop floor or warehouse. Inaccuracies routinely creep in due to several factors such as incorrect data entry in recording quantities, items or locations, system errors, transactions done that are forgotten to be entered in the system, pilferage, wrong quantities shipped on orders, unit of measures incorrectly entered, etc. These inaccuracies would keep growing with time, unless the inaccuracies are regularly identified and corrected. Physical Inventory and Cycle Counting processes achieve just that.

What is Physical Inventory?

Physical Inventory is a process of counting the entire inventory in a facility, and correcting inaccuracies in inventory records. Physical Inventory is generally conducted annually or biannually. Physical Inventory calls for stopping all the regular operations of the facility, and counting all inventory that exists in the facility. A snapshot of inventory data is taken at the start of the process. Physical inventory tags are printed, for tagging inventory and entering information of inventory counts. Deviations of counted inventory from system quantities are recorded and investigated. Deviations that can be explained are approved and system quantities are adjusted to reflect the actual on hand quantities.

Best Practices in Physical Inventory

Best practices in Physical Inventory can improve the effectiveness of the process. Some of the best practices in Physical Inventory are –

·        A mock count should be conducted, during planning of Physical Inventory, to accurately estimate the time and resources required for the count.

·        Suppliers, customers and production should be informed about Physical Inventory schedule, so that adjustments to supply can be made in advance.

·        Physical Inventory of slow moving SKUs should be conducted few days before the actual Physical Inventory, to minimize the amount to time the facility has to be shut down for Physical Inventory. These SKUs should be tagged and transactions on these SKUs should be frozen until the Physical Inventory is complete.

·        All defective and obsolete inventory should be disposed off before the Physical Inventory, so that time spent on Physical Inventory is reduced

·        System values of SKU quantities should not be displayed during counting and entering count quantities

·        Staff should be trained properly in Physical Inventory activities to ensure smooth progress of Physical Inventory. Personnel who know the facility well should be deployed for Physical Inventory.

·        Systems staff should be available for support if system issues are encountered during Physical Inventory activities.

·        Adequate supplies of stationary, food and drinks should be arranged for the Physical Inventory.

Physical Inventory is a disruptive process that disturbs the normal business operations of the facility. To keep the inventory discrepancies identified during Physical Inventory to minimum and to reduce the amount of time required to conduct Physical Inventory to minimum, periodic Cycle Counting of inventory is recommended.

What is Cycle Counting?

Cycle Counting is the process of counting certain items in inventory every few days in such that all the items in inventory get counted at least once every few weeks. In Cycle Counting process all SKUs are not counted with the same frequency – high value and high turnover SKUs are counted more frequently than low value and slow moving SKUs. Cycle Counting relies on ABC classification of SKUs to determine the frequency of counting each SKU.

Unlike Physical Inventory, Cycle Counting does not require shutting down of the facility, and hence does not disrupt normal business operations. This makes Cycle Counting less costly to perform. Another important benefit of Cycle Counting is that it is more effective in maintaining accuracy of inventory, because inventory discrepancies are identified early, and hence are more likely to be traced back to the sources of error.  

Best Practices in Cycle Counting

Some of the best practices in Cycle Counting that can make the process more effective are –

• Cycle Counting should be a part of normal operations of the facility
• Cycle counting should be scheduled to be done as frequently as possible. Higher the frequency of cycle counting higher will be the accuracy of inventory, and lower will be the inventory write-offs.
• A proper classification of items into ABC groups should be done. Item classification should be reviewed periodically (monthly or quarterly). Generally accepted thumb rules are that Group A should comprise of about top 70% of inventory value, group B next 15% and Group C the bottom 15% of inventory value. The best way to base ABC classifications is on value of shipments and value of inventory at hand.
• It is recommended that on an average every product should be counted at least once every quarter.
• Before cycle counting is performed all open transactions, such as receiving, shipping, WIP, should be closed out for the items that are selected for cycle counting.
• Sources of error should be investigated and action should be taken to prevent those errors from occurring in future. It is crucial to identify and fix process or training issues that cause inventory errors.
• Inventory accuracy metrics should be tracked over time and targets set for inventory accuracy.
• Coordination of activities of items being counted is critical in Cycle Counting. Either all transactions of items being counted should be put on hold, or effective processes should be in place so that all activities are correctly recorded and reflected in system as soon as possible.
• Cycle Counting should be done at the start of the day before the operations of the facility have begun in full-swing.
• Cycle Counting process should be well-defined and documented, and personnel should be trained in the process.

These are some of the practices that can improve the effectiveness of Cycle Counting. If deployed properly a good Cycle Counting program can eliminate the need for an annual Physical Inventory process.

Conclusion

A well-executed Cycle Counting and Physical Inventory program can lead to significant reductions in operational and inventory carrying costs. With increase in inventory accuracy, safety stock levels can be reduced thereby reducing inventory carrying costs.  Pilferage can be reduced when critical high value items are counted regularly (some can even be counted daily). Higher inventory accuracy leads to improvements in customer service levels and thereby enables increase in sales. It reduces or eliminates all the problems caused on account of lack of inventory accuracy that we talked about earlier in the document.

Cycle Counting and Physical Inventory processes play an important role in improving inventory accuracy and improving the performance of supply chain operations. Well-executed Cycle Counting and Physical Inventory processes are akin to oiling the wheels of supply chain, that keep the supply chain functioning smoothly, efficiently and at low cost.