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Audits of any kind are time-consuming and require manual work, but they provide an insightful deep dive into a business’s different accounts and/or financial situation.
When it comes to selling goods, ecommerce businesses may audit their inventory — whether it’s for tax purposes annually or to simply verify units on hand.
Inventory audits can be done in-house or by a third party and represent one point in time. Let’s dive into auditing one of your most valuable assets — your inventory!
What is an inventory audit?
An inventory audit is defined as the process of checking a company’s actual inventory levels against their financial records to ensure accurate inventory accounting. Inventory audits can be performed by the company or an outside auditor to identify any problems with the inventory storage and accounting methods a company is using.
They can be as simple as counting physical stock levels and cross checking against records, or as involved as hiring a third party auditor to assess all of your inventory procedures.
9 common inventory audit procedures
To audit your inventory, you’ll need to choose the method that makes the most sense for the purpose it serves and who is performing the audit. Here are a few of the most common inventory audit analyses and procedures used.
1. Cutoff analysis
Cutoff analysis is when you pause operations such as receiving and shipping at the time of the physical count to ensure nothing is being handled and goes unaccounted for.
You should communicate when you’re doing cutoff analysis with stakeholders and customers ahead of time so if delays occur as a result of the audit, they know why.
2. Physical inventory count
Physical inventory counts are done to make sure that your system’s numbers match up with your physical stock. This is done by counting each unit. Traditionally this was done manually, but the use of product barcodes and devices like inventory barcode scanners can streamline the process. Using an inventory management software can help you keep track of inventory during physical inventory counts.
By doing physical inventory counts you can improve demand forecasting, minimize stockouts, maintain inventory shrinkage, and more.
3. Analytical procedures
Doing analytical procedures during inventory audits involves comparing gross margins, inventory turnover ratio, and/or unit costs of inventory with previous years.
This helps you understand trends so you can be better informed during inventory procurement and when you’re forecasting demand.
4. ABC analysis
ABC analysis is when you group items of different value and volume together by high-value items (“A” products), medium value items (“B” products), and low-value items (“C” products).
You may even choose to store these items accordingly, so an auditor can pay closer attention to mainly the high-value inventory items.
ABC analysis helps you understand how to manage inventory and make informed decisions about what items to restock.
5. Freight cost analysis
Freight cost analysis determines the cost of getting inventory from one place to another, such as freight shipping costs and tracking the time between the date of shipment and the date of receipt.
This documentation accounts for any units that are in transit and also in case anything is lost or damaged in transit. Doing this analysis helps you make informed decisions about freight shipments, find out if you’re overspending, and gain greater visibility into freight shipments.
6. Finished goods cost analysis
A finished goods cost analysis is ideal if you create your own products. This type of analysis demonstrates when a product is ready to be sold so an auditor can immediately value the inventory for the current accounting period. Auditors may test this inventory to ensure financial statements are accurate. Learn more about finished goods inventory here.
By regularly completing finished good cost analyses, you are better informed when it comes to setting product pricing, placing orders for raw materials, and reduce inventory storage costs.
7. Overhead analysis
Overhead analysis helps you understand your business’s ongoing expenses. Knowing how much you’re spending on these indirect costs aids in budgeting. Outside of direct materials and labor, this analysis looks at “hidden” expenses such as rent, utilities, insurance, administrative costs, and other costs of doing business — if you record overhead as part of your inventory costs.
Keeping track of overhead costs shows what expenses are cutting into your margins and helps you achieve profitability.
8. Reconciling items
If there are discrepancies found in your inventory audit, you may wish to do a reconciling items investigation to determine the root cause.
In order to reconcile your inventory, you’ll want to follow these steps:
- Check your physical inventory counts to make sure you’re starting with an accurate count.
- Compare your physical count with your inventory records. This is where you’ll find any discrepancies.
- Look over shipment details, delivery info, and sales records to see where discrepancies took place.
- When you discover the cause of the discrepancy, create a “stock reconciliation statement” that overrides previous inventory records.
Learn more about inventory reconciliation here.
9. Match invoices to shipping log
You’ll want to double check your purchase orders or invoices against your shipping log to make sure there aren’t any discrepancies. Verify that invoices match the amount of items and cost of inventory shipped from your ecommerce warehouse. This may be done at random by an auditor to verify that the right amount was charged to the right customer at the right time.
By doing this two-way matching, you avoid shipping mistakes and duplicate charges, improve order accuracy, and ensure your customers are getting what they ordered.
Why inventory auditing is important for ecommerce businesses
An efficient inventory management process can reduce the frequency, length, and complexity of audits. Ecommerce inventory is different from physical retail stores, as sales can take place anywhere across the globe and are thus more unpredictable.
In a digital world, your inventory audit methods must match. Using technology that keeps inventory counts synced in real-time rather than using something static like Excel helps with the following.
1. Calculate profit
Inventory audits can help you calculate accurate profits, as the accuracy of your inventory accounting informs your bottom line. Tracking and accounting for changes in the value of inventory over time as it relates to manufacturing and costs of goods sold can drastically impact your accounting records. Inventory audits can prevent inventory shrinkage (or when the actual inventory levels are less than accounting has them recorded as) and identify costly slow-moving products.
2. Budget with accuracy
If you don’t have an accurate method for keeping track of your inventory’s value, you can’t budget for the next batch of inventory you need to purchase. Inventory audits can help you budget better and more accurately when you know the exact inventory count you’re running through, and how much safety stock you should keep.
3. Find inefficiencies
Audits can help you find inefficiencies, including inventory that’s not selling quickly (or much at all), SKUs that are selling out quickly and causing frequent stockouts, inaccuracies with storage or inventory tracking techniques, and other operational errors.
You can use this information to improve the financial health of your business by discontinuing unsuccessful products, doubling down on what’s working, and optimizing other areas of your supply chain — from manufacturers to warehouse locations.
4. Optimize your inventory holding
Holding costs are the sum of all costs related to carrying inventory including warehousing, labor, insurance, and rent, combined with the value of damaged, expired, and out-of-date products. The longer you hold inventory and the more unusable inventory you have, the more money you pay. Inventory audits can help you limit these factors.
Best practices for smoother inventory auditing
Inventory audits can be challenging – there are many moving parts and factors to consider. Here are some general inventory management tips to make the process go more smoothly.
Identify & prioritize inventory items
First you’ll want to select what inventory you want to include in the audit process and prioritize that inventory from most important to less important. If you haven’t completed an audit in a while (or ever before), you’d want to run and audit your entire product catalog. During more regular inventory audits, you may choose to only prioritize high-value items.
Gather important documentation
Auditors will require various documentation to complete your audit. Having that information at the ready will make the process much easier and more efficient. You should have inventory records, invoices, shipping and receiving reports, and proof of inventory ownership like a bill of sale. You can also provide an auditor with a manual of your inventory protocols so they can better understand how you manage inventory.
Schedule recurring audits
When you haven’t completed an inventory audit in a while, they can be complicated and you can unearth more discrepancies than you expected. By doing regular audits you’re able to catch minor issues before they become major problems and ensure inventory is at the right level.
You should be running inventory audits at least once or twice per year. Performing audits quarterly is a better timeframe to catch discrepancies and issues.
Run the audit without bias
Running an audit can be rife with bias for internal stakeholders. For example, if the person completing the audit is the same person who was instrumental in creating processes, they might not be able to see when inefficiencies are holding the business back. Sometimes, an external auditor can provide a more impartial view of where you stand. They ask the tough questions that can be overlooked when an internal auditor completes a report.
Regardless if an internal or external auditor is completing the reporting, they should be able to impartially consider theft, mismanagement, inefficiencies, damage and inventory obsolescence.
Record and share results
Once you’ve completed your audit, it’s important to share your findings with stakeholders and staff. This way you can share where you found discrepancies and change processes if necessary to ensure those types of issues arise in the future. Making a record of these discrepancies and share them with the team so they can refer back to it to resolve issues, if needed.
3 challenges of performing an inventory audit
Inventory audits can be an incredibly challenging task to perform. And the bigger the business, the more complex it becomes. Here’s what you may encounter.
1. It’s time-consuming
Auditing physical inventory is very tedious. Think about it: If you sell 500 SKUs and you check actual inventory levels against the amount of inventory you have listed on hand electronically or in an inventory sheet, that can take you days, if not weeks, to complete.
Even if you have one SKU and 3,000 units, you’re going to spend a while on a manual task. Going electronic with inventory reports is key to saving time, with access to the most up-to-date information across locations. 3PLs like ShipBob help with this.
“We have access to live inventory management, knowing exactly how many units we have in Texas vs. Chicago vs. New York. It not only helps with our overall process in managing and making sure our inventory levels are balanced but also for tax purposes at the end of the year. ShipBob simplified the entire process for our accountants and us.”Matt Dryfhout, Founder & CEO of BAKblade
2. It’s difficult to scale
The bigger you get, the more strategic you’ll need to be with inventory solutions. Spot checking can be a more manageable way to keep inventory audits under control in between full physical inventory audits. This means choosing a specific product, counting the number of units on hand, and comparing it to the number of units listed in the system.
“I felt like I couldn’t grow until I moved to ShipBob. Our old 3PL was slowing us down. Now I am encouraged to sell more with them. My CPA even said to me, ‘thank god you switched to ShipBob. ShipBob provides me clarity and insight to help me make business decisions when I need it, along with responsive customer support.”Courtney Lee, founder of Prymal
Inventory management technology can help simplify inventory methods by prompting a spot check when the system marks the product stock as zero to confirm there are no more units on hand.
3. It can halt operations
If you pause everything to conduct an inventory audit, you halt operations, which includes order fulfillment and getting items shipped to customers. In the age of Amazon, meeting customer expectations around timely delivery can influence their experience and impression of your product and brand.
Easily improve audit efficiency with ShipBob’s inventory management software
Stock control is difficult, but the use of tools can help streamline it. Ecommerce businesses of all sizes can outsource fulfillment to ShipBob to receive the fulfillment services, warehouses, and technology needed to compete today.
But if outsourced fulfillment isn’t for you, ShipBob also has a warehouse management system (WMS) that brands can leverage to manage and track their inventory.
Learn more about how ShipBob’s proprietary system can help your brand with inventory audits and management.
1. Forecast demand
Auditing inventory helps you understand current counts, but it’s another thing entirely to use data to make future business decisions. Demand forecasting is predicting future orders by using historical data. This enables a business to make better decisions around inventory planning, product storage, and marketing promotions while meeting customer expectations.
ShipBob’s analytics provides the following distribution metrics and data visually:
- Which items are slow-moving
- How many days of inventory you have until you are expected to run out (based on SKU velocity)
- How your current demand compares to previous time periods
- How your sales are affected by different seasons and months
- How much inventory you were holding at any ShipBob fulfillment centers at any point in the past
- Your best-selling items and the percentage of your business they account for
- And much more
2. Store product in the “right” location(s)
Part of making inventory management more efficient includes optimizing your inventory storage system. This means both within a warehouse and by zooming out to understand where in the world you should keep inventory. Thus, good inventory management software should not only help you review all of your SKUs but also connect your shipping data to close the loop.
For example, ShipBob’s software helps you understand where to distribute your inventory across its network of fulfillment centers by analyzing your past order history. This is so you can keep inventory closer to your customers, reducing the shipping zones, transit times, and shipping costs. When an order is placed, ShipBob’s algorithm automatically matches the order to the warehouse that has the available inventory and is closest to the customer.
“ShipBob has fulfillment centers in major cities all over the US, so we can spread out our inventory across the country and leverage ground shipping as an inexpensive alternative to expedited air shipping.”Founder of My Calm Blanket
If you’re using ShipBob’s WMS, you can take a hybrid approach to fulfillment. You can fulfill orders from your own warehouse but leverage ShipBob’s global network of fulfillment centers to reach domestic and/or international customers more quickly and cost-effectively.
“We wanted to outsource international fulfillment to alleviate the pressure put on our in-house team (and high costs and long transit times for our customers), while dialing in on making our own warehouse more efficient. We began vetting warehouse management systems that would provide structure and make our processes and workflows more efficient. I met with ShipBob and felt like they would be a good partner because they could offer all of the solutions we needed.”Jourdan Davis, Operations Manager at Pit Viper
3. Stay accurate and reorder on time
With software like ShipBob’s, you can view the status of your inventory and know when to proactively replenish inventory. Using your store’s order history, ShipBob can help project when you should send more inventory to prevent stockouts — no need to do manual reorder point calculations each time. You will be alerted to restock at the SKU level.
Additionally, you can manage how SKUs are grouped to bundle products, merge the same SKU across stores, and add new SKUs with ease.
“We roll out new products and designs on our website 1-3 times a month and send new inventory to ShipBob each week. It’s really easy to create new SKUs and restock existing ones using ShipBob’s technology, which is especially important with high inventory turnover.”Carl Protsch, Co-Founder of FLEO Shorts
It’s important to conduct inventory audits to maintain inventory accuracy, identify shrinkage, and ensure that you always have enough (but not too much) stock at any time. Outsourcing inventory management and fulfillment to a 3PL can help. They will take measures to keep your inventory safe and secure, without you having to do any of the time-consuming work yourself.
ShipBob’s WMS (the same one that powers ShipBob’s global fulfillment network) can be used to streamline in-house inventory management and fulfillment. With real-time, location-specific inventory visibility, intelligent cycle counts, and built-in checks and balances, your team can improve inventory accuracy without sacrificing operational efficiency.
For brands looking to scale internationally, ShipBob even offers a hybrid solution where merchants can employ ShipBob’s WMS technology in their own warehouses while simultaneously leveraging ShipBob’s fulfillment services in any of ShipBob’s fulfillment centers across the US, Canada, Europe, and Australia to improve cross-border shipping, reduce costs, and speed up deliveries.
Inventory audit FAQs
Here are answers to the most commonly asked questions about inventory audits.
What is the purpose of an inventory audit?
Inventory audits are done to ensure your inventory counts match up with your records. This helps you maintain inventory accuracy, identify shrinkage, and ensure you have enough inventory oh-hand to fulfill customer orders.
Are inventory audits mandatory?
While inventory audits aren’t required by law for private companies, businesses should conduct these reports regularly if they want to ensure their processes are running smoothly, they have enough inventory on-hand (toeing the line between too much and too little), and that they are streamlining warehouse operations.
Depending on your financial situation (if you rely on banks or investors), you may need to provide them with yearly or quarterly inventory audits. The institution may also note whether they require it to be an external audit or an internal audit.
Is inventory auditing difficult?
Inventory audits can be challenging because they’re often time-consuming, tedious, and require an impartial view of your operations. However, there are steps you can take to make the process a little bit easier. Conducting regular audits to catch minor issues before they become major problems, keeping track of necessary documentation for easy access, and using an inventory management software (like the one included in ShipBob’s software) can help you make inventory audits a more seamless process.
What is the difference between a physical inventory and an inventory audit?
Doing physical inventory counts is the process of manually (with pen and paper) or electronically (with SKUs and scanner) counting all of your on-hand inventory in the warehouse. This is usually done at year-end in preparation for the next year. Inventory audits add a layer on top of a physical inventory count by assessing if any of the following has occurred: theft, obsolescence, damage, or misplacement.