What to Count and How Often
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All inventory must be included in the counting procedures at least once during the year. A popular method to schedule the counts is the ABC method. Under this method, the inventory items are designated based on value or number of inventory turns as A items, B items, or C items.
The A items are considered most critical and are counted frequently throughout the year. Typically these are inventory items that turn over often or have high value. The C items typically have less movement or carry a lower value and therefore may be included in the count only once or twice during the year. Accordingly, the C items are expected to carry a lower risk of material differences. Any given inventory count includes a large number of A items, some B items and very few C items.
Whatever counting method is used, the frequency of inventory counts is important. The counting process ideally occurs on a daily basis — weekly at a minimum.
Placing controls on the cycle count process will help maintain the integrity of the counting process and the number of times inventory items are counted during a given year. If a scheduled item is not counted, or is swapped for an easy-to-count item or an item that is known to possess an accurate quantity, the validity of the sample is compromised. As a result, any issues residing beneath the surface like stock shortages, unidentified spoilage or unrecorded transactions could go undetected, greatly undermining the goals of the cycle counting program.
The business should also perform blind counts to restrict the ability to make changes to the counted results. Blind counts are performed without knowledge of the quantity that is listed in the accounting records. If blind counts are not performed, the person performing the count may see the system quantity on the count sheet and simply match its count to the system quantity to avoid the hassle and additional time of investigating variances. By exercising discipline in performing blind counts, this risk is virtually eliminated. Some companies even use a double-blind counting system, which involves a second count team that recounts, on a blind basis, certain components or locations of inventory.
Tolerance for Variances
Also critical to an effective cycle counting program is the development and implementation of a tolerance threshold for investigating count variances. A company should document count differences in both quantities and dollar amounts, and the differences should be measured on their gross (absolute) value. To be useful, the tolerance threshold should not be too high. If many individual differences are uncovered but the aggregate net quantity or dollar variance is minimal, an underlying issue is still causing the inventory variances. The fact that a net difference is low could simply be the fortunate result of the particular sample that was selected for counting. A sample on a different day could produce dramatically different results if the error frequency is similar but the differences are consistent instead of netting out to a small difference
For example, a company counts 100 inventory items on one day and finds differences for 10 of the items. Some of the differences are overstated and some understated, so the net dollar difference is a small amount. The next day, again the company counts 100 inventory items and again finds differences for 10 of the items. This time, however, the differences for all 10 items are directionally consistent that is, they are all either overstated or all understated and therefore the overall difference is more significant.
This phenomenon — where the key underlying problem is the error rate — highlights the importance of evaluating the dollar differences in terms of their absolute value instead of net value. If a company can eventually achieve a variance rate of less than 1%, the system is likely to be accomplishing the desired objective. However, results and expectations can vary among businesses.
When implementing a tolerance threshold for count variances, it is important that the investigation process occur as designed and that the count discrepancy resolution process be documented well. The business should determine error thresholds that automatically trigger both a second count by a different individual and an investigation of the cause of the error. An experienced separate individual should perform any second counts the program requires. Any differences that remain unreconciled after the second count and, after examining shipping and receiving activity, should be adjusted in the system.
If problematic trends become obvious, management might determine that it is necessary to flag various locations or types of products and perform additional counts on these items. In some cases, it might be possible to increase test-count coverage by changing the characteristics in the cycle counting program (for example, changing a B item to an A item, or providing for certain flagged items to be selected on a more frequent basis).