Inventory Audit: Process and Best Practices

Imagine your eCommerce business is booming, and orders are flooding in. 

But amidst this retail frenzy, have you ever wondered if your inventory records truly match what's on hand? Are you confident that your stock levels are accurate? Is your business operating with optimal efficiency? Well, it's time to have a clear snapshot of your inventory count. 

Enter inventory audit. The very word "audit" often sends shivers down the spines of most business owners. However, by understanding the inventory audit’s nuances beforehand, you can be well-prepared for what lies ahead and position yourself for success.

In this article, we’ll walk you through the world of inventory audits, exploring their significance, standard inventory audit procedures, the challenges they present, and best practices to ensure seamless auditing of inventory.

What Is an Inventory Audit?

The success of any business relies on efficient inventory management. An accurate inventory count is paramount for managing supplies and predicting restocking needs. 

An inventory audit, also known as a stock audit, is a process that uses analytical procedures to cross-check a company's financial records of inventory with its physical count. 

Simply put, the number of units recorded in your inventory management software should match the stock quantity physically present on your sales floor or warehouse.

Let's say an online retail brand is conducting an inventory audit for its warehouse. As part of the physical inventory count, the employees check every item. Aided by advanced technology, stock audit tallies the products on hand. 

That said, having an external perspective is always advantageous in an inventory audit. Hence, some companies prefer to have external inventory auditors. A third-party auditing firm is not part of the company's everyday operations. This makes the auditors unbiased in cases of theft, mismanagement, inefficiencies, and damage. 

During the inventory audit process, the auditing firm not only confirms the stock quantity but also assesses the stock condition. Subsequently, they evaluate the instructions and procedures provided by management for recording and controlling the count results. 

Note that inventory auditors do not perform the complete physical inventory count for the business. Instead, they oversee and verify the accuracy of the count conducted by employees.

There are two main categories of audits:

1. Internal Audit: Involves examining processes, assets, and inventories within the company. An internal auditor conducts it and reports to the CEO or senior management. It helps companies prepare for external audits or address uncertainties in inventory.

2. External Audit: An independent accountant conducts it. The results certifies an entity's financial statements. Investors, lenders, and publicly traded companies seek this certification for confidence in financial accuracy.

What are the objectives of auditing inventory?

The main objectives to audit stocks are—

1. Inventory reconciliation

For cross-referencing inventory records with physical stock to address any discrepancies.

2. Examining the Operations Accuracy

For assessing the accuracy of the inventory counting system using statistical sampling methods.

3. Ownership Rights

For verifying the company's rightful ownership of the recorded inventory.

4. Evaluation of Realizable Value

For examining whether inventories are reported at the correct value in the general ledger. And if damaged or low-quality items are accounted for reflecting their realisable value.

By accomplishing these stock audit objectives, companies can maintain reliable inventory data and confidently make informed business decisions.

How Do You Conduct an Inventory Audit?

Conducting an inventory audit doesn't have a one-size-fits-all approach, but certain stages and activities are standard across most audits.

Step One: Inventory Forecasting

Running out of stock during a stock audit is the last thing any business wants. To avoid this, thoroughly analyse the available data for demand forecasting before the inventory audit. 

Step Two: Identify Items

Decide which inventory will be audited. You can count all items or prioritise based on value or risk.

Step Three: Schedule Inventory Audit 

A good rule of thumb is to plan the stock audit at a time that is the least disruptive to daily operations. For many eCommerce businesses, that means overnight.

Step Four: Collect Documents

Gather all necessary documents for an accurate and efficient auditing of inventory.

Step Five: Audit Stock 

Select the most suitable inventory audit procedure for your needs. Ensure to use an unbiased and experienced inventory auditor for the most accurate results.

Step Six: Record Findings

Document the audit findings to identify areas for improvement in operational processes.

Step Seven: Report Findings

Create a comprehensive report that compares the current audit to past and future audits. It should give you a complete vision of where your business has been and where it’s headed. If any item discrepancies are found during the audit, investigate them thoroughly.

Step Eight: Keep Historical Records

Archive the inventory audit findings for future reference and to assist future managers in conducting audits.

11 Best Audit Procedures for Inventory

1. Physical Inventory Count

This is the go-to method using spreadsheets. It physically counts all items and compares them to the recorded level in your inventory system. 

2. Inventory Cycle Count

Similar to physical counting, but focuses on a limited number of items regularly. It allows more frequent audits of high-value items, preventing inventory loss concerns.

3. Analytical Procedures

Compares metrics like inventory turnover ratio, gross margins, unit cost of inventory, and inventory days on hand to past years' numbers.

4. ABC Analysis

Categorizes goods based on their monetary worth. Enables you to prioritise and audit specific groups. Also helps you organise your warehouse to streamline inventory audits.

5. Cut-off Analysis

Temporarily pauses warehouse operations, such as shipping and receiving, for a physical inventory count. It ensures accurate financial reporting without any inventory changes being overlooked.

6. Overhead Analysis

Examines indirect costs (e.g., rent, utilities, insurance) and their impact on the overall inventory cost when included by the business.

7. Finished Goods Cost Analysis

Applies to retailers who manufacture their products. Includes value of finished goods inventory when it is ready for sale for the current financial period.

8. Freight Cost Analysis

Evaluates freight shipping costs, shipping time, and cost damage during transit. Understanding shipping costs is vital as they are often part of the inventory value.

9. Inventory Reconciliation

Involves resolving discrepancies between financial statements and the physical inventory on hand. Errors are re-checked and reconciled in financial records.

10. Shipping Invoice Matching

Matches the cost of shipped goods to the number of items sent. It ensures no items are shipped at the wrong price.

11. Inventory in Transit Analysis

When inventory is transferred between locations, auditors review transfer documentation and include that inventory in the count.

Top 7 Benefits of Inventory Audit for Ecommerce Businesses

In the dynamic world of eCommerce, maintaining accurate inventory count is crucial for success. A systematic inventory audit verifies stock levels, ensuring financial health and customer satisfaction. 

Let's explore why inventory audits are essential for your online business—

1. Ensuring Accurate Stock Levels

Accurate inventory counts are vital for managing customer expectations. It helps prevent issues like order cancellations or overstocking. Regular audits help spot discrepancies and inefficiencies in the inventory management system. 

2. Identifying Discrepancies

Audits reveal discrepancies caused by theft, damage, or data errors. You can promptly align your inventory with actual stock by detecting these issues.

3. Preventing Manipulation of Financial Records

Mistakes or intentional alterations by internal parties can occur during record preparation. Inventory audits ensure such errors are caught and prevented, safeguarding the integrity of financial documentation.

4. Managing Cash Flow

Effective inventory management directly impacts cash flow. Audit procedures for inventory help identify slow-moving items that can be discounted to free up cash. Also, timely reordering prevents stockouts and maintains a healthy cash flow.

5. Planning Accurate Budget 

Accurate inventory tracking is essential for budgeting future purchases. Inventory audits provide precise counts and safety stock data, improving budget accuracy and planning.

6. Catching Shrinkage

Shrink is the lost inventory in the retail industry. It accounts for the items leaving without payment due to theft, damage, or poor stock-keeping. Retail shrink resulted in losses of $94.5 billion in 2021, marking an increase from $90.8 billion in 2020.

Inventory auditing detects shrinkage early, thus preventing phantom inventory and stockouts. It also allows investigation and addressing the root causes of shrinkage for your eCommerce store.

7. Maximise Inventory Storage Efficiency

Holding costs include inventory carrying costs such as storage, labour, insurance, rent, and the value of damaged or expired items. The longer you retain merchandise, the more you spend, and the more useless goods accumulate. Inventory audits help control these factors.

What Are the Perils of Inventory Audit? How to overcome them?

While inventory audits offer numerous benefits, they also come with challenges that businesses must be aware of. Some common roadblocks you may encounter are as follows. Don’t worry! The PACK & SEND team also shares tips to overcome them.

1. Operational Disruptions

Large-scale inventory audits can disrupt regular business operations, causing delays and impacting customer service. We recommend you to:

• Plan inventory audits during periods of lower activity.

• Use software with built-in cutoff analysis for efficiency.

• Train staff to maintain operational efficiency.

2. Time Constraints

Conducting an inventory audit process requires time. Which can be a challenge for small businesses with limited capacity. To avoid this:

• Plan and schedule audits in advance to minimise disruption.

• Embrace technology like barcode scanning for quicker processing.

• Research reliable software options to save valuable time.

3. Difficult to Scale

Scaling audits as your business expands can be notoriously complex, especially with multiple stockrooms, warehouses, and sales channels. The following step will help:

• Implement a centralised inventory system for seamless data management.

• Use automation tools for real-time tracking and synchronisation.

• Establish standardised processes for consistency and accuracy.

• Spot check to keep audits under control between full physical counts. 

• Consider an inventory control system like perpetual inventory to ease the burden.

4. Employee Resistance

Employees might resist change or feel apprehensive about the audit process. To engage your employees in inventory audit procedures:

• Communicate the importance of inventory accuracy and audit.

• Extend proper training on inventory audit procedures. 

• Involve them in the planning and execution stages to foster ownership and cooperation.

Prioritise Stock Audits to Optimise Your eCommerce Business's Performance

Performing inventory audits is key to maintaining accuracy, identifying shrinkage, and achieving stock-level perfection. Outsourcing heavy lifting of inventory management and fulfilment to a reliable 3PL, like PACK & SEND, can be a game-changer. 

We'll safeguard your inventory, handle the nitty-gritty, and ensure smooth operations. If you're ready to level up your eCommerce order fulfilment game, contact PACK & SEND today! Get pricing and discover how we bring top-notch inventory management tools to the table, tailored perfectly for your business. 

Frequently Asked Questions (FAQs)

What exactly is an inventory audit?

An inventory audit, also referred to as a stock audit, is a systematic process that verifies the accuracy of inventory records and the physical inventory count. 

How often should you conduct an inventory audit?

The frequency depends on your warehouse size and needs. At a minimum, aim for once or twice a year, preferably near the end of a financial reporting period. For better visibility, quarterly audits can help you track your business's seasonality effectively. 

How do you conduct an inventory audit?

• Gather all relevant documents like purchase orders and receipts.

• Verify accuracy by comparing records with actual inventory to ensure they match.

• Physically count items and document the results.

• Check if the inventory is enough to meet customer demand.

• Investigate and resolve any differences between records and actual inventory.

• Document and share the audit results with management.