A properly prepared trial balance is the key to accurate company valuations and is also the basis of your annual balance sheet. For this reason, it is very important that there are no errors. Your trial balance should consist of a list of all assets and liabilities. But what exactly is a trial balance? We will explain what you need to look out for and show you an example of what your trial balance...
What is inventory?
Many startups and smaller businesses in particular find it tricky managing their inventory count on a regular basis, especially because it involves a lot of personnel. This is why we will explain exactly what is behind the term and what you have to pay attention to when it comes to your inventory. And to ensure that your next inventory count runs as smoothly as possible, we also provide you with tips on how you can carry it out easily and efficiently.
Inventory counts are not only necessary for tax purposes, but they also help you as the business owner to be able to calculate the value of your own company. However, the act of inventory counting isn’t new: More than 500 years ago, the Italian mathematician Luca Pacioli (a good friend of Leonardo DaVinci) recognised this. He not only described double-entry accounting in his works, which Italian merchants used at that moment, but also advised the entrepreneurs of his time to use inventory counts as a core component of the balance sheet.
- Inventory count: Definition of stocktaking
- Why is inventory management so important?
- How to carry out an inventory count
- How often should you carry out an inventory count?
- Case study: Company with good inventory management
Inventory count: Definition of stocktaking
The Inventory count or stocktaking procedure refers to the physical verification of the quantities in an inventory or warehouse, and what kind of condition they can be found in. By carrying out the annual inventory count, you can determine what both your assets and your debts are composed of. All a company’s assets (and all its debts) should be written down in list form. The purpose of this procedure is to determine the actual inventory. Traders and entrepreneurs should regularly determine what is in their warehouses with the help of a merchandise management system. Taking an inventory count enables a company to know exactly what stock and assets it has, and how to locate these quickly. It also determines whether the inventory you thought you had, is correct. It is not uncommon for the actual inventory to not correspond to the book balances. Here are five main aims of an inventory count:
An organised system enables you to get an overview of your sales channels and keep on top of how much stock you have and where it is, if you have multiple warehouse locations.
Controlling your costs
You can work out which stock is doing well and which products aren’t worth ordering or selling anymore if they’re just gathering dust.
Improving your delivery
You know when to expect deliveries so you don’t end up keeping customers waiting if you realise you’re out of a particular item. You can ship to customers when and where they want their delivery.
Managing planning and forecasting
Software can be used to analyse data trends from well-performing stocks. Being able to predict what will happen means you can plan better.
Decreasing the time for carrying out an inventory count
If you have a good management solution for inventory management, it’s easier to keep track of all your available products, which saves you time in the long run.
Why is inventory management so important?
A good inventory system can be the difference between a successful company and an unsuccessful one. Some companies have the potential to make a lot more profit, but don’t achieve this due to operating ineffectively. If the company isn’t 100% sure what it has in stock, it might lose sales if there’s not enough of a particular item in stock and it therefore can’t meet demand. The opposite scenario is also annoying: when you think a certain item is out of stock when it isn’t. This leads to more being ordered and the customer having to wait longer for no reason. This also means that storage isn’t being efficiently used since these “out of stock” items are taking up space without serving as a possible revenue stream. Worst case scenario: the customer will go elsewhere, maybe even to your competition.
Companies need to know their assets for tax and operational reasons. Assets can include equipment and stock, for example. If these are taken care of, it means your cash flow statement will be accurate. The rate at which stock and equipment depreciate in value lowers the taxable income of a business, which means the business pays less taxes.
How to carry out an inventory count
Now you know the reasons that companies perform inventory counts, you now need to decide what you want to count during the stocktake. If you come up with a plan beforehand, it’ll help the process run a lot smoother and quicker. Here are some examples of the categories that can be counted:
- Saleable items: Anything being sold to a customer (most popular category to count).
- Maintenance items: Items that don’t become part of the end product or are not central to the company’s output.
- Raw materials: These are the component parts that haven’t yet been used in the work-in process or finished goods production.
- Furniture, fixtures, & equipment: Noting these down can be valuable in case of damage or theft.
- Rental or movable equipment: Makes it easier to track items moving across locations, event temporary ones for events or field operations.
- Vehicles: Companies should have an idea of how many are in use, which employee is currently making use of them, and where they are.
Some companies only have one location, whereas others have many. No matter how small a location or warehouse, it’s important to carry out an inventory count in every place that’s important to your business. If certain areas are quite large, tackle them in stages so it’s easier to keep an overview. Don’t forget that some of your items might be in transit (i.e. in service vehicles or an employee’s car) or on loan. Any products you have that are broken or have been returned should be put to the side so as not to be confused with the current stock.
Choosing when to perform the inventory count can be tricky. During operating hours isn’t recommended since you might end up with a not-so-accurate result if the process is rushed and also customers will be coming in and buying products as you’re counting them. Therefore, it makes sense to either perform the stocktake after hours, or close the shop for a while, but don’t forget to inform customers.
Traditionally, physical inventory counts are done with pen and paper and many business owners prefer this tried and tested method. The products are tallied up and then entered into the system. While successful, this method is relatively inefficient and requires you to enter all the products twice (first on paper, then into the system). Some companies use hand scanners to make light work of the task. These can be rented if you don’t want to purchase them for your company.
Using inventory management software, such as that from Vend, facilitate the workload and save time.
Choosing the right staff for the inventory count
Estimate how long the count should take so that you can calculate how many staff should be needed. To help you estimate, carry out a “practice test” on a small amount of stock, then multiply that time by the remaining areas that still need to be counted. This is how you work out how many people are needed then add an additional person since you will be organising people and may not have time to do any of the counting yourself. The helpers should consist of seasoned staff as well as several newer employees who will see things with a fresh set of eyes.
Make sure that each staff member knows the plan i.e. should they be working left to right, or top to bottom? When an area has been checked, make sure it’s marked off so no-one attempts to do it again. Have a central point in mind so that anyone needing help can go there and have their questions and queries answered. A printout for each helper could be useful if the procedure is starting to get complicated.
What are the different methods for inventory accountability?
There are two common methods for inventory accountability in the UK:
- Weighted-average cost method
- First in, first out (FIFO) method
Generally Accepted Accounting Principles (GAAP) allows both methods to be used. Most other countries use the International Financial Reporting Standards (IFRS), which doesn’t approve of the LIFO (Last in, first out) method, which is allowed in the US, for example. Another difference between GAAP and IFRS is that they differ on inventory reversal write-downs and costing formulas. With GAAP, the reversal of previously recognised write-downs is not allowed in subsequent periods whereas under IFRS, a write-down to net realisable value is recognised as an expense in the period in which it occurs.
How often should you carry out an inventory count?
When evaluating your inventory process, you should decide how often you need to carry out an inventory count and which type is the right one for you. The exact regularity of stocktaking differs from one company to the next with some companies choosing monthly inventory counts, and some opting for once a year. This all depends on the company’s inventory turnover and how successful it’s been in the past when it comes to inventory numbers being accurate without a full audit being required. Companies with fewer items don’t need to carry out audits as frequently. If bigger companies opt for fully automated inventory systems, they may not require personnel to carry out the stocktake, which saves time and money. Full counts should be carried out at the end of the financial year, although your accountant might recommend you do one at your mid-financial-year point. Other recommended times are before you sell your business and after really busy periods such as Boxing Day or Black Friday sales.
Perpetual or cycle counting
As long as you have a good computerised inventory system, the perpetual counting system (often referred to as “cycle counting”) can save you money as well as increase the accuracy of the count, and not disrupt your operation as much while it’s being carried out. Many business owners choose this method since annual physical inventories are a lot more complex and therefore come with a higher chance of errors being made. Since the perpetual method is carried out by software, it makes sense for you to do a few random spot checks (i.e. of high-theft items) throughout the year to make sure the software is giving accurate results. GAAP as well as IRS rules require you to either count your complete inventory on a yearly basis or to implement a perpetual counting system. Cycle counting is especially beneficial for retailers since it means the shop doesn’t need to be closed while it’s taking place.
This method is quite similar to cycle counting but is slightly more systematic. Some businesses choose to perform periodic complete counts every three to six months to check the method’s accuracy. An advantage of opting for this method is that any losses incurred due to theft can be deducted from the tax.
The seasonal method can consist of spot inventory counts or complete counts. The main reason for choosing this is when seasonal trends change or there’s product spoilage. For example, a clothing business might perform an inventory count as the season is coming to an end to make sure it has sold all the stock it planned to sell that season and to prepare for the next season’s products to be stored in its place. In the food sector, stock needs getting rid of if it hasn’t sold since it may violate health codes if it’s near its sell-by-date.
An annual inventory count is common for businesses that don’t use cycle-counting procedures or software, or don’t have many items. Many companies also perform yearly inventory counts in order to rectify any mistakes made in the software since this loss can go towards tax deduction. An end-of-year-stocktake is carried out to be used in the company’s financial statements. Sometimes external auditors are present whose job is to audit the financial statements.
Case study: Company with good inventory management
The multinational technology company, Apple, knows its stuff when it comes to successful inventory management. It closely manages its supply chain by trying to keep inventory low, having few warehouses, and letting suppliers fight it out amongst themselves to work together with the giant.
Keeping inventory level low is especially important for companies that sell technology since a competitor might release a new device at any time, meaning no-one is interested in buying your company’s “outdated” stock.
It’s not cheap to keep moving inventory around and having lots of warehouses. Apple decided to have its suppliers ship their parts to a factory located in China, so that when a buyer orders something, the finished product is shipped directly from the factory, which cuts out several steps and saves time.