An Overview to Physical Inventory: Definition and Computation - ChicagoShipper

Peter Drucker’s famous line, “If you can’t measure it, you can’t improve it,” tells so many things when it comes to life and company aspects. 

The same is true for inventory management. It is hard to fulfill consumer demand and maintain an effective supply chain if inventory is not frequently updated, tracked, and accounted for. 

Physical inventory counts may be tedious and time-consuming. However, by putting in place procedures and systems that provide a clear picture of stock availability, you can correctly track a large volume of inventory in less time. 

In this blog, we will explore why physical inventory accounting is crucial, recommended practices to follow, and how you can outsource fulfillment to make inventory management much easier. 

Physical Inventory Definition 

Physical inventory refers to the sellable products you have on hand that has been tallied by weight, measurement, volume, and/or units. 

To guarantee that actual inventory counts match inventory records, this sort of inventory necessitates tracking and controlling products at the SKU level. 

Because physical inventory is classified as an asset, it must be accounted for at the end of each accounting period. 

Physical inventory counts may be performed by developing systems and procedures that measure inventory levels in real-time and employ automation to manage inventory movement across the supply chain, from warehouse receipt through returns handling. 

Physical Inventory Types Often Computed 

The type of inventory you must keep track of for inventory accounting reasons is determined by your company. 

A direct-to-consumer (DTC) brand is often needed to track finished goods that are ready to sell to the end customer, whereas a manufacturer is required to track raw materials and things in production. 

Here’s an overview of the many forms of physical inventory that are tracked along the supply chain. 

  • Raw Materials 

Raw materials (also known as production inventory) are unprocessed resources or primary commodities used by a company to make finished goods. 

Raw materials can be regarded as sellable in some circumstances because they are ready to sell to another firm, such as flour and sugar needed to produce bread; wood, plastic, and metal used in furniture manufacture; or bolts of textiles and fabrics for a design house. 

  • Work-in-Process 

Work-in-Process (WIP) refers to partially completed objects that are currently in the production process. These products have been modified but have not yet reached the level of final goods. 

A reusable drinking bottle, for example, that is presently being molded with materials such as plastic and stainless steel might be termed WIP since it still has to be painted and packaged before it can be sold. 

  • Finished Items 

What constitutes ‘finished products’ is determined by the supplier and the client. A seller’s finished items, for example, may become a buyer’s raw materials. 

From a DTC standpoint, finished items are an online brand’s most valuable asset. Once received by the manufacturer or supplier and held until things are ready to be fulfilled, finished goods are sorted by SKUs and judged ready to sell to the end-user. 

You may manage the movement of inventory from what’s been received to what’s been sent by keeping track of completed goods inventory and current stock levels. 

  • MRO Stock 

Maintenance, repair, and operations (MRO) refer to the tools and equipment needed for the upkeep, repair, and operation of manufacturing equipment necessary to produce completed items. 

These units are seldom used in the production of commodities, but they are regarded as inventory items in e-commerce bookkeeping. 

Though MRO supplies are not directly related to sales, they are considered an overhead expenditure and can have an influence on profit margins. 

Different Ways to Count Physical Inventory 

There are two techniques for counting physical inventory: manual and automated. In any case, physical inventory must be counted on a constant basis to assure inventory correctness at all times. 

Here’s a rundown of the most frequent ways for counting physical inventory. 

  • Manual Completion 

Manual completion entails physically counting and documenting current inventory levels, as well as updating records if there is a change. 

You must count the value of your inventory and divide it by the value of the inventory you are intending to have depending on what you’ve sold and how much you recently ordered. 

Manual physical inventory counts take time, and there is a considerable possibility of discrepancy and human mistakes, which can have an influence on balance sheets and profit statistics. 

Pointer: If your inventory accuracy is poor, constantly refer to your sales receipts and records. This might disclose the disparity (e.g., you may have sold the missing inventory). 

  • Electronic Computation 

Online businesses are already adopting digital inventory solutions through the use of supply chain technology. 

Electronic counting is performed using an inventory monitoring system or any other sort of technology meant to improve visibility by tracking data and collecting information as things travel through the supply chain. 

A firm may measure how much e-commerce inventory is accessible, where things are placed, and how each SKU performs over time by integrating inventory management software or a more complex solution such as an ERP inventory system. 

Electronic counting systems offer precise real-time inventory counts, which greatly simplifies inventory optimization. 

Because many businesses lack the resources to do manual inventory counts, computerized counting is becoming the standard and is gradually displacing traditional inventory management methods. 

  • Counting By Cycle 

Cycle counting is a form of manual approach in which inventory is divided into more manageable sub-segments (such as location) and physically counted on a regular basis. 

Many organizations utilize the “ABC categorization” approach to conduct a cycle count, which involves counting faster-moving products more frequently (e.g., weekly or monthly) than slower-moving commodities (e.g., quarterly or annually). 

Higher-value products may be prioritized above what is in high demand in some circumstances, but it ultimately boils down to whatever inventory has the most influence on income. 

If you operate a warehouse and don’t want to slow down operations, the cycle counting approach is excellent. It aids in breaking down the inventory counting procedure into smaller activities, lowering operating expenses and making the process less uncomfortable. 

When is it appropriate to count physical inventory? 

To determine how frequently you should count physical inventory, you must first choose between a perpetual and a periodic procedure. 

  1. Because using a periodic inventory system necessitates manually updating records only after a specified accounting period, inventory counts are not updated after each sale.
  2. Meanwhile, the perpetual inventory system necessitates the ongoing updating of records with each receipt or sale of commodities. 

This perpetual inventory approach is ideally suited for warehouse inventory management for organizations dealing with big inventory quantities since it is done automatically using point-of-sale systems. 

It is totally up to you and your team to determine when to count physical inventory. To make the best option, however, it is always better to talk with an accountant. 

Best Methods For Physical Inventory Counting 

Physical inventory counting may appear to be a difficult operation, but there are techniques to streamline the process so that you are not spending all of your time counting goods and updating records. 

Here are some best practices for inventory management that you can easily include in your operation. 

  • Disagreements must be addressed swiftly. 

Inventory shrinkage can be caused by issues such as lost or stolen products, while undersold inventory can amass what is known as ‘deadstock.’ 

Physical inventory counts might assist you in identifying inventory issues sooner rather than later. Inventory reconciliation must be done on time to ensure that all e-commerce inventory is accounted for.

If you discover any differences throughout the process, you should prepare a “stock reconciliation statement” that explains the anomalies (if possible) and overrides your earlier information. 

  • Select attentive employees. 

The attentiveness and training of your team will increase the speed and accuracy of your present physical inventory counts. 

If you or your team lack the time and resources to manage and track inventory on a continuous basis, you may want to explore collaborating with a 3PL to assist you to improve the inventory management process while saving your team time. 

  • Use technologies such as scanners. 

Implementing an inventory scanner system can help increase inventory accuracy. 

Inventory scanners are wireless, making it simple to scan a product wherever it is stored and identify each SKU type using barcodes. 

You can quickly monitor things by SKU, check how much is in stock, and know where each SKU is stored in a warehouse by adding a barcode to your product tags or packaging. 

  • Make use of inventory management software. 

Investing in inventory management software is worthwhile since it eliminates the tedious, error-prone, and time-consuming process of manually managing inventories. 

This program is intended to automate time-consuming activities and track inventory in real-time, even across numerous channels and warehouses. 

There are numerous options on the market with varying levels of capability based on your requirements, such as multichannel inventory management. 

However, if you do not want to spend more time and money on your own software, you may work with a tech-enabled 3PL that includes digital inventory management systems as part of their fulfillment capabilities at no additional cost. 

  • Automate the administration and tracking of your physical inventory. 

As your e-commerce firm expands and inventory becomes more expensive or difficult to oversee and handle in-house, it may be time to collaborate with an e-commerce fulfillment provider.