Cycle Counting and Physical Inventories
So it's the end of the year and the warehouse workers and all the salaried employees are gathered together on a Saturday morning to perform the annual physical inventory. The coffee and donuts help to put color into the faces and cover up the odors enveloping those who had overindulged themselves the night before. People are wandering around not sure what they should be doing, when the boss walks in with stacks of reports, cards, and colored stickers and says "OK here's how this is going to work." By noon it's obvious that less than half the warehouse has been counted and the pizza lunch has left everyone with an enthusiasm deficit. At two o'clock, one by one, people start approaching the boss with the reasons as to why they have to leave. Suddenly the pressure increases on those remaining to get finished. Five o'clock and the last of the counters are abandoning ship, there's an enormous pile of paperwork marked "discrepancies" and several piles of product marked "unknown," "what's this?" and "needs to be identified." The boss surveys the scene and instructs the people in charge of investigating the overwhelming pile of discrepancies to "just make the adjustments, we need to get out of here." With some variations, this is how annual physical inventories are performed year after year. So what’s wrong with this process? Everything!!! You’ve just had a group of people with inadequate training and experience — most of them forced into being there on their day off — count your inventory, and have then made adjustments to your on-hand balances based on those counts without having the time to adequately investigate the variances. The final result likely being that half of the adjustments corrected previous inventory problems while the other half created new inventory problems on items that were correct prior to the inventory. In case it’s not obvious to you, I don’t like annual physical inventories. Counting inventories on a regular basis throughout the year (cycle counting) combined with a process for continuous improvement in inventory accuracy will prove a far better method for achieving accurate inventories. My definition of cycle counting tends to differ slightly from the generally accepted one. Most people think of cycle counting as regularly scheduled (usually daily) counting of product where you randomly count items based upon some type of predefined parameters. For example, inventory is broken down by ABC classifications and frequencies assigned such as A items counted 10 times/year, B items 5 times/year, and son on. I prefer to define cycle counting as any count program using regularly scheduled counts where you count less than the entire facility's inventory during each count. This includes a system that I’ve found to be highly effective, that is a hybrid of a physical inventory and a cycle count, where you’re counting all inventory within a physical area like a physical inventory, however, you are not counting the entire facility at one time. The next day you simply start where you left off the day before. Regularly scheduled physical inventories can be an effective way of counting inventory in smaller operations provided you are using trained counters and have adequate time to investigate the discrepancies prior to making adjustments. If your inventory is so extensive that you cannot adequately investigate the count discrepancies, you must break it down into some sort of a cycle count program. If you are running a successful and comprehensive cycle counting program, there is little benefit to performing an annual physical inventory. Unfortunately, many in the financial establishment still live in the Dark Ages when it comes to inventory counting and will try to tell you that “you must perform an annual physical”. Once again I’ll state that if you can count and adequately investigate count discrepancies in a single day, then go ahead and perform the physical. However, if your inventory is too extensive or if you are in a 24/7 operation, do not want to shut down operations, and feel confident in the accuracy of your cycle count program, you can pressure them into accepting some type of on-site audit instead. They generally don’t like it but they will do it.
So it's the end of the year and the warehouse workers and all the salaried employees are gathered together on a Saturday morning to perform the annual physical inventory. The coffee and donuts help to put color into the faces and cover up the odors enveloping those who had overindulged themselves the night before. People are wandering around not sure what they should be doing, when the boss walks in with stacks of reports, cards, and colored stickers and says "OK here's how this is going to work." By noon it's obvious that less than half the warehouse has been counted and the pizza lunch has left everyone with an enthusiasm deficit. At two o'clock, one by one, people start approaching the boss with the reasons as to why they have to leave. Suddenly the pressure increases on those remaining to get finished. Five o'clock and the last of the counters are abandoning ship, there's an enormous pile of paperwork marked "discrepancies" and several piles of product marked "unknown," "what's this?" and "needs to be identified." The boss surveys the scene and instructs the people in charge of investigating the overwhelming pile of discrepancies to "just make the adjustments, we need to get out of here." With some variations, this is how annual physical inventories are performed year after year. So what’s wrong with this process? Everything!!! You’ve just had a group of people with inadequate training and experience — most of them forced into being there on their day off — count your inventory, and have then made adjustments to your on-hand balances based on those counts without having the time to adequately investigate the variances. The final result likely being that half of the adjustments corrected previous inventory problems while the other half created new inventory problems on items that were correct prior to the inventory. In case it’s not obvious to you, I don’t like annual physical inventories. Counting inventories on a regular basis throughout the year (cycle counting) combined with a process for continuous improvement in inventory accuracy will prove a far better method for achieving accurate inventories. My definition of cycle counting tends to differ slightly from the generally accepted one. Most people think of cycle counting as regularly scheduled (usually daily) counting of product where you randomly count items based upon some type of predefined parameters. For example, inventory is broken down by ABC classifications and frequencies assigned such as A items counted 10 times/year, B items 5 times/year, and son on. I prefer to define cycle counting as any count program using regularly scheduled counts where you count less than the entire facility's inventory during each count. This includes a system that I’ve found to be highly effective, that is a hybrid of a physical inventory and a cycle count, where you’re counting all inventory within a physical area like a physical inventory, however, you are not counting the entire facility at one time. The next day you simply start where you left off the day before. Regularly scheduled physical inventories can be an effective way of counting inventory in smaller operations provided you are using trained counters and have adequate time to investigate the discrepancies prior to making adjustments. If your inventory is so extensive that you cannot adequately investigate the count discrepancies, you must break it down into some sort of a cycle count program. If you are running a successful and comprehensive cycle counting program, there is little benefit to performing an annual physical inventory. Unfortunately, many in the financial establishment still live in the Dark Ages when it comes to inventory counting and will try to tell you that “you must perform an annual physical”. Once again I’ll state that if you can count and adequately investigate count discrepancies in a single day, then go ahead and perform the physical. However, if your inventory is too extensive or if you are in a 24/7 operation, do not want to shut down operations, and feel confident in the accuracy of your cycle count program, you can pressure them into accepting some type of on-site audit instead. They generally don’t like it but they will do it.
By Dave Piasecki
