Avoiding excessive inventory carrying costs requires maintaining accurate inventory records. One of the most efficient ways to maintain that accuracy is by implementing inventory cycle counting practices. Those practices enable a manufacturer to verify that its perpetual or continuous inventory records remain accurate, without incurring the costs and business disruptions associated with conducting wall-to-wall physical counts.
For cycle counting purposes, a manufacturer’s total inventory may be divided among numerous categories. Those category classifications may be based on various product lines or customers. Categories may also be based on sales volumes, product costs or other criteria. A manufacturer, for example, may devise 12 different inventory categories. By dividing its total inventory into those 12 segments, a different category can be physically counted each month.
While cycle counting affects some operational functions each month, production can continue while various inventory items are counted. Totals gleaned from those monthly cycle counts are then compared to the perpetual inventory records, which are records updated from receipts for product purchases and sales to customers.
Any variances between cycle count totals and perpetual inventory sums can be examined to determine the root causes of those discrepancies. Corrective measures can then be taken. Once such cycle counting becomes a routine practice, a manufacturer may realize substantial operational and financial benefits.
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Knowing that perpetual records are accurate allows a manufacturer to determine the appropriate levels of safety stock that must be maintained to meet customer requests. Material requirements planning processes can be refined to avoid unwarranted inventory buildups. While a manufacturer may still need to conduct an annual physical count of all inventories, it will have the accurate information it needs throughout the year to address such operational concerns.
Beyond aiding in operational decisions, accurate inventory records gleaned from cycle counting practices allow company managers to make more informed decisions. Increases in a particular inventory category, for example, may indicate the onset of a downward cyclical trend, while a decrease in some other inventory classification may signify improving economic conditions. That information enables managers to respond to potential vulnerabilities as well as opportunities.
Such information is also crucial for maintaining and improving a manufacturer’s financial health. Inventory is the primary component of a manufacturer’s cost of sales. That cost of sales measures profitability as well as operational efficiency. Cost of sales is key to determining gross profit. The cost of writing off obsolete inventory that cannot be sold must also be recorded in financial statements.
The financial impact of inventory management practices extends to tax concerns, too. For income tax purposes, inventory is considered a taxable asset, an asset that increases a manufacturer’s tax obligation. By reducing inventory levels whenever possible, a manufacturer lowers that obligation.
Cycle counting enables a manufacturer to maintain accurate inventory records in an efficient manner—a manner that does not require the cost and effort associated with wall-to-wall physical inventories, a manner that can be sustained from month to month, and year-to-year. Having such cycle counting practices in place helps a manufacturer realize the operational, financial and tax benefits that accompany effective inventory management practices.
Shawn M. Parker, CPA, [email protected], and partner-in-charge of Dallas assurance services for Weaver, the largest independent certified public accounting firm in the Southwest with offices throughout Texas.