Inventory Audit: A Comprehensive Guide With Best Practices and Procedures

It’s your business’s busy season, and warehouse workers are packing orders fast. But they run into a roadblock: Your records say 200 units of a product are available, and there are only 195 on the shelf. And another five of those products are damaged and unfit for sale. That means you have 190 units to sell, not 200.

Instead of risking 10 customers not receiving what they ordered, conduct regular inventory audits to avoid that situation in the first place. These procedures check whether or not written records match the goods in stock and whether or not those goods are fit for sale.

Here’s how to develop inventory audit procedures that count products accurately and identify issues before they arise. 

What is an inventory audit, and why is it important?

Inventory audits involve counting and evaluating a business’s material goods and comparing that information to its records. The process is similar to an inventory count, but instead of just quantifying stock, you qualify it, too — meaning you check for damage, spoilage, or mistakes. This leads to a more accurate view of what’s sellable.

While these audit procedures are time-consuming, they’re the key to accurate recordkeeping. They can help you:

• Identify discrepancies: You obviously shouldn’t have gaps between what the records say you should have and what’s in stock. Those gaps could mean lots of inventory shrinkage. Once you discover the existence of a problem, you have a chance to fix whatever is causing it.
• Budget for upcoming purchases: A detailed inventory audit lets you prepare for future orders. You can predict the number of goods sold and incoming revenue, offering insights into the money you will have to spend in the future to replenish your inventory counts.
• Facilitate stock optimization: Ordering enough inventory to match demand lowers holding costs and avoids stockouts. An important component of this process is having accurate inventory counts so you don’t accidentally reorder too many or too few units.
• Improve workflow efficiency: Missing inventory signifies inefficiencies in your workflows, like items getting lost during transportation or problems with warehouse inventory management software. Knowing there’s a shortfall helps you identify and remedy these process issues. 

The 7 most common inventory audit procedures

Here’s how to audit inventory valuation with seven different techniques.

1. Physical inventory count

A physical inventory count involves counting the items in your company’s possession and comparing them with the records in your inventory management software. If your business is supposed to have 5,000 widgets based on real-time inventory tracking, count the number of widgets you have and make sure there are actually 5,000. Also flag any items that are damaged or otherwise can’t be sold.

For companies with thousands of items in stock, this process can be time-consuming and impractical. But if your company follows a just-in-time inventory method or doesn’t keep a lot of stock on hand, physical counts are straightforward and accurate. Also, barcode scanners make the inventory count process much faster and the data more reliable. With a simple barcode scan, your warehouse workers bring up in-depth details on each item in the warehouse. And they can instantly update inventory quantities.

2. ABC analysis

An ABC analysis begins by dividing items for sale into different product groups based on profitability and their value to the brand. For example:

• “A” products are the most critical. They may be essential to business operations or have the highest value. For an outdoor goods business, these might include popular items like tents and lanterns.
• “B” products have a lower value than “A” products but are still crucial to the brand. While camping chairs aren’t as popular in the outdoor goods store, customers still expect to find them for sale. 
• “C” products are the least valuable goods in your inventory. These could include premade camping meals, niche products, and other goods that are less popular and have a lower profit margin.

Grouping items with this method lets you focus resources and efforts on the most impactful items while counting and auditing inventory. 

3. Analytical procedures

Analytical procedures compare year-over-year inventory data and use that information to assess current systems. For example, you might compare inventory turnover, items returned, or gross margins to previous numbers. This makes forecasting future demand easier because you can see trends in consumer behaviors and inventory statuses. 

4. Finished goods inventory 

Finished goods are items ready to sell to customers at any given time, excluding any items that are damaged or not ready yet, like kits that haven’t been packed. Calculating their value predicts how much income to expect later. Determine the value of the starting inventory, add the cost of the goods purchased or manufactured since you last calculated the starting inventory, and subtract the cost of goods sold. 

Auditing finished goods helps you avoid stockouts since you know what’s truly available. And measuring how quickly you sell finished goods lets you plan future production to improve lead times and reduce excess storage costs. 

5. Overhead analysis

Inventory is about more than physical items. It’s also about the indirect costs of storing those items, like rent, utilities, and administrative expenses. An overhead analysis examines these business costs so you can budget and set prices that reflect the true cost of production while staying competitive in the market. 

6. Freight cost analysis

A freight cost analysis helps you better understand the total costs of transporting goods, including any hidden costs like fees for crossing borders or carrier charges. Look at the last month’s shipping data, including expenses, shipping routes, and volume of products. Identify opportunities to increase efficiency and decrease costs, like consolidating smaller shipments or shipping at off-peak times, to save money and boost customer satisfaction.

7. Cutoff analysis

To perform a cutoff analysis, briefly pause certain operations, like shipping and receiving items, then conduct a physical inventory count. Depending on your inventory, the count could take a few hours or days, so budget your time accordingly and pause operations at a convenient time. This helps you get the most accurate picture of what’s in stock without risking missed items or double counts by moving products in or out. 

How to conduct an inventory audit: 5-step checklist

You can conduct an audit in-house or hire an inventory auditor to provide a specialized service, but regardless of the approach, follow a systematic process to ensure accuracy. Here are the main steps to take.

1. Prepare and plan 

Before beginning the audit, organize the warehouse or office space so it’s easy to access necessary information. Decide what the audit’s goals are and choose procedures that match them so you know what resources you need. For example, performing a physical inventory count requires the coordination of time, tools, and multiple staff. 

2. Execute

After determining what type of audit to perform, it’s time to execute the process. This could mean reviewing financial records to identify overhead costs, analyzing purchase and sales transactions to conduct a finished goods inventory count, or physically counting the items in your warehouses. 

Whatever approach you take, be sure the team knows how to perform the audit correctly to avoid wasting time or energy. Schedule the process at a time when it won’t disrupt normal operations, and make sure it follows the outlined steps to avoid errors. 

3. Analyze the results

Compare the data and see if it matches expectations. Depending on the type of audit, this could mean determining if you have the total number of products expected, comparing actual shipping costs with projections, or assessing whether or not you’ve prioritized the correct products to reorder. 

4. Identify and address discrepancies

Carefully review the data for patterns or discrepancies. For example, you might find certain overhead costs are higher than anticipated or that you’re missing a type of product at a particular warehouse.

By identifying where and how the data doesn’t match expectations, you can create an action plan to address the issues, like improving inventory management techniques in warehouses that lose items. 

5. Improve future audit processes

Inventory management is important, and it doesn’t stop after one audit. When you finish conducting an inventory audit, identify the process’s pain points and streamline opportunities to continually refine the procedures. 

This could mean changing how you keep shipping records to better analyze the cost of specific items. You could also explore new software solutions like Fishbowl that integrate with and automate current processes. 

3 inventory auditing challenges

While inventory audits are essential, they do present challenges. Potential roadblocks could include:

1. Time: Inventory audits can be tedious and take a long time. Larger businesses may face challenges scaling up their processes as tracking greater amounts of goods becomes increasingly arduous. Developing more strategic solutions and harnessing the power of software tools can help. 
2. Human or technical errors: Errors can arise at many points during the process, from human errors in counting physical inventory to inaccuracies in valuing damaged inventory. Establishing streamlined procedures and providing proper staff training can minimize these mistakes.
3. Operations slowdown: If you perform a cutoff analysis, you must pause business operations to collect the correct data. Time the audit correctly so it interferes with regular business as little as possible. 

4 best practices for successful inventory audits

Following best practices can make audits easier and earn you the practical data needed to streamline operations in the future. Some best practices include:

1. Setting up a consistent audit schedule: Frequent inventory audits, like monthly, quarterly, or annual ones, offer consistent data. By becoming more familiar with the numbers to expect, you can spot problems earlier.
2. Providing ongoing training for your team: When staff members understand inventory audit procedures, they can perform more efficiently and effectively, and you reduce the risk of human error. 
3. Streamlining the audit process using technology: Barcode scanners and inventory management software can reduce errors and make collecting data easier. 
4. Performing small-scale inventory audits: You don’t have to do everything all at once. Consider starting small. Divide the warehouse into zones and perform an inventory audit on one zone at a time to avoid overwhelming employees with the scale of the job.

Use Fishbowl for powerful audits

Fishbowl makes inventory audits easy with real-time inventory management and QuickBooks integration. These tools provide up-to-the-minute stock visibility and insight into your most crucial processes so you can optimize inventory management across the entire organization. Try it today for an easier tomorrow.