15 min read

How to Do Inventory Audits: Procedures, Benefits, and Tools

Chloe West

Last updated on Aug 27, 2024

QUICK SUMMARY

It's always good to know what you've got in stock—that's your money there. Which is why you gotta audit your inventory from time to time. In this guide, I'll take you through the steps to do that. Once you know what you got, you can sell it, right?

TABLE OF CONTENTS What is an Inventory Audit? 9 Common Inventory Audit Procedures The Inventory Audit Process 7 Best Practices for Inventory Auditing Inventory Audit FAQs

Your ecommerce brand’s inventory is one of its most important valuable assets. This is why it’s so important to ensure your inventory count is accurate and that you’re properly stocking up each item.

Part of staying on top of your inventory includes inventory audits.

An inventory audit does a deep dive into your company’s inventory to verify accuracy, identify potential inventory shortages, and minimize fraud and theft.

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However, there are different auditing processes and procedures that different companies prefer.

Throughout this guide, you’ll learn more about the importance of inventory audits and how to audit inventory for your ecommerce business.

Let’s get started.

What is an Inventory Audit?

An inventory audit is an analytical procedure that checks a company’s inventory against its financial records to ensure accuracy.

This process verifies that the actual count of goods matches with the recorded count of goods, ensuring that your inventory management system is working and that there has been no product loss throughout the time period.

Oftentimes, an inventory audit involves simply counting all of your remaining product during a set time period and matching those numbers up with the numbers in your inventory management software to see if there are any discrepancies.

Why inventory audits are essential for ecommerce brands

Running regular inventory audits—although the frequency will depend on the type of business and inventory you have—is an important process for any retail business.

Some businesses only need to conduct these audits once per year, while others (typically ones that sell perishable items) may conduct them monthly.

An inventory audit is so essential because it can help your business:

Discover discrepancies: US retailers reported an average of 1.6% in inventory shrinkage ($112.1 billion in losses) in 2022—through auditing. Find out if your actual count is different from where the count should be based on your inventory tracking. Depending on how large the discrepancy is, you can launch an investigation to figure out why it’s happening.
Avoid over or understocking: Audits can help you discover whether you have certain stock staying on the shelves for too long or which are running too low, so you can readjust your inventory ordering.
Detect product loss: Product loss can occur due to theft, damage, or spoilage. Conducting regular audits can help you identify potential loss issues so that you can deal with and minimize them.
Pinpoint warehouse efficiency issues: Inventory shortage can be due to inefficient warehouse processes. Your audit may be able to uncover these issues so they can be resolved.
Comply with regulations: Public companies are required to run third-party inventory audits in order to be compliant with regulations—that is, according to the AICPA Auditing Standards and the Public Company Accounting Oversight Board (PCAOB), if their items are what is considered “material.” The Generally Accepted Accounting Principles (GAAP) states that an item is considered material if “its omission or error could influence the economic decisions of those who rely on the financial statements.”

9 Common Inventory Audit Procedures

Illustration of these 9 procedures infographics

There are several common auditing procedures that can help retail companies get accurate inventory counts.

Some of these can be used together, while others will depend on how your company runs.

Physical inventory count

A physical inventory count is done by individually counting each unit in order to measure inventory levels.

Though traditionally done manually, a barcode scanner can also be used to assist in the process.

This is usually done just once, at the end of the fiscal year or accounting period. That’s because a manual inventory count is a massive undertaking, even with the help of inventory management tools.

Cycle counting

Cycle counting is a more frequent process.

This procedure is a systematic count of different areas of inventory, rotating through different departments or types of product.

While a physical inventory count of all inventory happens just once a year or so, cycle counting can help discover discrepancies in the meantime.

Cutoff analysis

Cutoff analysis is the process of cutting off all operations in your warehouse to ensure no inventory enters or leaves during the counting process.

This helps boost inventory accuracy by ensuring that no items are being counted during the wrong accounting period.

You’ll want to communicate with your customers ahead of time if you’re doing a cutoff analysis so they know to expect delays in shipping.

ABC analysis

ABC inventory analysis is when you categorize your inventory into three groups (i.e., group A, B, and C) based on value.

For example, group A consists of high-value items, group B consists of medium-value items, and group C consists of low-value items.

You can use SKU numbers and barcodes to help prioritize your products.

If you choose this process, you may even want to store your items in these different categories to help make inventory auditing easier.

The ABC analysis process helps you allocate your resources during an audit more effectively (think about it: you’re going to want to prioritize your higher value items during the internal audit).

In addition, ABC inventory analysis can be used as a form of cycle counting.

You’d conduct more frequent cycle counts for your A group versus the B and C group as you want to keep a closer eye on your higher-value inventory.

Freight cost analysis

Freight cost analysis looks into shipping costs from carrying inventory from one place to another, which can be an important figure to look at in your financial reporting.

Analyzing this can give you an idea of all shipping and freight-related costs, providing potential opportunities to negotiate better freight rates, find inefficiencies in the supply chain, and improve delivery times.

For example, your current freight rates might be a passive cost that you aren’t always paying attention to.

If you do a freight cost analysis every year, you can get a clear picture of what you’re paying, then research to see if you see lower rates elsewhere.

If so, you may be able to use those lower rates to negotiate better costs at your existing company.

Finished goods cost analysis

Finished goods cost analysis works best if you create your own products.

It takes into account direct materials and labor, along with manufacturing overhead costs.

With this analysis, your team determines when a product is ready to be sold, so auditors can include it in their inventory valuation process.

Overhead analysis

Overhead analysis involves auditing the indirect costs associated with producing your goods.

This might include things like rent, utilities, insurance costs, administrative fees, and more that you might not normally consider, ensuring you don’t underestimate the total cost of inventory.

Inventory count reconciliation

Reconciliation is the process of matching up your physical inventory count to your accounting records.

If any discrepancies are discovered, you’ll need to work to reconcile them and find out why.

This process will look a little something like this:

Perform your physical inventory count to get an accurate count of your existing stock.
Compare your count to your inventory records to see if they line up.
Pinpoint any discrepancies and investigate into why they might have occurred.
Check shipping logs, sales records, invoices, and other records to see if you can find answers.
Reconcile the inventory record to match your actual count. If you found the reason for the discrepancy, create a “stock reconciliation statement” that shares why. Otherwise, simply adjust your figures to match the actual count so you have accurate figures moving forward.

Match invoices to shipping log

With this process, you’ll double-check your invoices or purchase orders against your shipping log to make sure there are no discrepancies amongst those documents.

This is an automated process that most accounting software can help with.

Here, you can ensure that your customers are receiving the correct items and that there haven’t been duplicate orders going out.

Simplify your inventory audits—learn how a perpetual inventory system provides real-time accuracy and reduces audit discrepancies.

The Inventory Audit Process

Now that you know some procedures you’ll be using as you audit your inventory, let’s walk through the three-step auditing process.

Step 1: Preparing for inventory auditing

To minimize errors and maximize efficiency, you’ll want to start with a clear-cut preparation phase. This will involve tasks like:

Choosing the right timing: Because auditing inventory items brings operations to a standstill, you’ll want to choose the right timing to schedule your audit so that it minimizes disruptions. For example, you wouldn’t want to pause operations for an inventory audit during the holiday season. However, if there’s a slow period throughout the year, that may be the perfect opportunity.
Getting organized: Organize your inventory, minimizing pallets and putting everything in place, to ensure that the audit goes as smoothly as possible.
Preparing documentation: Gather all of your records and conduct a quick review to ensure that you have all the documentation you’ll need to audit and reconcile your inventory. This could include your inventory records, invoices, shipping logs, and any other documents used to reconcile your inventory.
Setting goals and objectives: Set goals for your audit, like validating your inventory management process, identifying inventory shrinkage sources, increasing forecasting capabilities, or improving cost-effectiveness.
Training your team: Make sure your team knows how to do inventory to minimize errors throughout the process.
Taking advantage of technology: Use the relevant features of your inventory management software or warehouse management software to help streamline the overall process.

Step 2: Conducting the inventory audit

Now it’s time to start your audit. Follow along with these tasks to fulfill this step:

Choose the right procedure(s): We’ve already gone through the different procedures necessary for conducting an inventory audit. Choose the one(s) that will best work for your inventory.
Execute your count: Start your count using your chosen procedure(s). Count each individual item and record the quantity on your balance sheets.
Reconcile the count: Match the numbers up to those on your inventory software. Investigate any discrepancies you find.

Step 3: Analyzing the results

Finally, once your audit/count itself is complete, you need to analyze the results. Follow along with these tasks to do so:

Identify patterns in your discrepancies: Review your reconciliation documents to see if you can discover any patterns in discrepancies, like specific products or areas of your warehouse that tend to be most inaccurate. Then, see if you can pinpoint the reasoning, like inefficient processes, supplier issues, or even internal theft.
Evaluate the effectiveness of your chosen procedure: Did you choose the right process (or mix of processes) for auditing your inventory? How accurate was your count? Should you try something else going forward?
Develop an action plan to move forward: Once you’ve completed any investigations into discrepancies, put together a plan to minimize them in the future. This may be switching suppliers, finding different software, letting go of some team members, or even moving to a different warehouse location.

7 Best Practices for Inventory Auditing

Want to improve your inventory auditing process? These seven best practices can help.

1. Use the best inventory management software

One way to instantly improve your inventory management is with the right software.

These online tools can be extremely beneficial to your processes, helping to minimize error and give you even more inventory control.

The right inventory management software for improving your auditing should include capabilities for automated reorder points (automatically ordering new stock when it hits a certain threshold to help avoid stockouts) and stock level alerts (notifications when stock hits a certain point).

These features are useful for keeping an eye on stock levels and knowing when you’re ordering more.

You can also use these features as alerts for when you should conduct a mini-audit to ensure that the stock levels actually are as low as the software says—and that they should be.

Here are our favorite inventory management solutions for simplifying all the work of maintaining accurate stock levels:

2. Automate and track inventory in real-time

Tools like automated tracking and real-time inventory updates can help reduce errors and discrepancies in the long run.

When you’re able to keep an eye on stock levels throughout the year, it creates less room for surprises come auditing time.

Plus, you can get access to smart tech like barcode scanners and RFID that help streamline processes both before and during the audit.

Barcode scanners help make the counting process faster—and keep you from losing count.

RFID tags can help companies keep an eye on inventory movement, ensuring it makes its way through the supply chain. This is a great way to boost warehouse efficiency alongside improving your auditing processes.

3. Integrate with ecommerce platforms and tools

If you’re running an online store, your inventory records will look different from a brick-and-mortar store with built-in storage space.

This means you’ll need software that can work together to keep a proper eye on everything.

Find an inventory management tool that integrates seamlessly with your ecommerce platform so that you can more easily track inventory as it enters and leaves your fulfillment center.

More than that, check out all available integrations to see what other tools you can enlist the help of to improve your processes.

Some of these tools may include:

4. Minimize human error

Auditing can be difficult. It’s time-consuming and relies heavily on minimizing human error.

This means you need to properly train your employees—and consistently keep them up-to-date on the software and processes—to ensure they know exactly what’s expected of them come auditing season.

Another way to minimize human error is to hire expert auditors to handle the process for you.

Public companies are required to do this in order to comply with auditing standards.

5. Conduct regular and external audits

Make sure you’re always prepared for auditing time by creating a consistent schedule.

For example, implementing cycle counts every month and full physical inventory counts at fiscal year-end.

It’s also a good idea to hire external auditors periodically so they can conduct unbiased evaluations and ensure that all of your inventory records are fully accurate.

These are typically done once a year.

6. Train and standardize procedures

Like we mentioned, keeping your employees up-to-date on the procedures is key.

But even more important—especially as team members join and leave the company—is standardizing your procedures and properly documenting the entire process.

This way, you can add your auditing processes into the overall onboarding and regular training of your employees.

Test different counting procedures to find the one that works best for your company and your team, then standardize that process by adding it to your company’s training materials.

7. Embrace technology

Technology is your friend—especially in such a manual and tedious process like counting inventory.

Take advantage of the tools at your disposal.

Of course, we’ve already mentioned the benefits of inventory management software, but there are AI tools and mobile apps for things like predictive analytics and on-the-go management that can offer additional support.

For example, most warehouse management systems (WMS) should run on a mobile app to help streamline the process.

Final Thoughts

The bottom line is that every retail and ecommerce business needs to conduct at least annual inventory audits to make sure their inventory turnover records are fully accurate.

This guide will help you ensure that your inventory count lines up as closely as possible to your financial statements.

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Inventory Audit FAQs

Still got questions? We thought that might happen. Here are some extra Qs and As that might satisfy your curiosity (fingers crossed).

Is inventory auditing hard?

Inventory auditing can be difficult as there are a number of challenges your team may face. First of all, it’s a time-consuming process.

In addition, it’s difficult to scale, making the process even harder as your company grows. However, with the right processes in place, you can make it as manageable as possible.

How often should inventory audits be done?

Inventory audits should be done at the end of each fiscal year—though some companies may need to perform audits more frequently.

What is the risk of inventory auditing?

As with any process, there’s always a risk for error. When you have people physically counting your stock items, there will always be a margin of error due to incorrect counts.

What is a cycle count?

A cycle count is when a company counts smaller groups of inventory at various cycles throughout the year, rather than (or perhaps in addition to) a massive full inventory count once per year.