A physical inventory is the process of verifying the quantities and condition of items in stock by actually counting and inspecting the items. This process typically involves counting all inventory items and recording the quantities, then comparing these counts to the quantities listed in the company’s inventory records.
Physical inventory is usually performed periodically (such as annually, semi-annually, or quarterly) but can also be done on a continuous basis (known as cycle counting). The primary objectives of conducting a physical inventory are:
- Verifying book records: To ensure that the actual quantities of inventory match the quantities reported in the company’s accounting system or books.
- Preventing theft and loss: Regular physical inventory checks can help detect theft or other losses, as well as errors in record-keeping.
- Assessing the value of inventory: To verify the value of the inventory, which impacts the company’s balance sheet and profit & loss statements.
- Improving inventory management: Physical inventory checks can provide valuable insights for inventory management, helping the company identify which items sell quickly, which are slow-moving, and whether there’s excess or obsolete stock.
The results of a physical inventory count can lead to adjustments in the company’s financial and inventory records. If discrepancies are found, it may be necessary to investigate the causes, which could include theft, damage, data entry errors, or issues with purchasing or sales processes.
Example of Physical Inventory
Let’s use the example of a clothing store, “Style Central”.
At the end of each fiscal year, Style Central conducts a physical inventory of all items in the store.
- Preparation: Prior to the physical inventory count, the store manager, Lisa, organizes the inventory, ensuring all items are in their designated areas. She also trains her staff on the correct procedures for counting and recording inventory.
- Counting: After the store closes on inventory day, Lisa divides her team into pairs, assigning each pair a specific section of the store to count. They count each item of clothing (dresses, shirts, pants, etc.), recording the type, size, and quantity on inventory count sheets.
- Verification: Once the count is complete, Lisa takes the inventory count sheets and compares the numbers to the inventory records in the store’s computer system.
- Investigation of Discrepancies: Lisa finds a few discrepancies. For example, the physical count found 25 pairs of a specific type of jeans, while the computer system lists 30. Lisa checks the sales records and finds no sales were missed. After further investigation, she concludes that five pairs of jeans were likely stolen.
- Adjustment: Based on the physical inventory, Lisa adjusts the computer system to reflect the actual count of 25 pairs of jeans. The value of the missing jeans is written off as a loss, impacting both the value of the inventory and the store’s profit for the year.
- Follow-up: Lisa decides to implement a more robust loss prevention strategy to reduce theft in the future. She also decides to conduct physical inventory counts quarterly instead of annually to keep better track of the inventory.
This is a simple example of how a physical inventory process might work in a retail store. The exact procedures can vary depending on the nature and size of the business, the type of inventory, and the company’s inventory management policies.