Year-end inventory valuation not easy but necessary

Taking a physical inventory on or as close to the end of the year is the obvious way to do this. But the process is not easy. You have to shut down operations, bring on additional people, spend hours in a mad dash to count every product in your storeroom, spend more hours inputting data and trying to resolve discrepancies (or at least the worst of them). Then there is the reconciliation with Finance and, often, the bad news about a large variance between the count results and the general ledger value.

But a year-end physical inventory may not be the only way to get an accurate valuation of the asset. There is a better way. Perhaps it is time to implement one of the easiest of best practices – a cycle counting program.

Cycle counting is an inventory control and accuracy process. As the name implies, you "cycle" through your inventory counting small pieces of it. Over time you count every line item. There are various ways to pick which lines to count each time and how frequently to count, but in every case all lines are counted at least once each year. There are numerous advantages to the cycle count program including:

• Counts can be taken during slow periods

• The storeroom can remain open during inventories

• There is a better chance that discrepancies will be discovered before they
   become stockouts

• There is time to investigate and resolve discrepancies

• There is more opportunity to discover discrepancy patterns

• The root cause of discrepancies can be found and corrected

• Physical counts are more accurate as there is less fatigue

• There is more time for recounts

• The inventory – both quantities and value – stays more accurate

Further, in most cases a well-run cycle count program can eliminate the need for an annual physical inventory. This is not, however, automatic. Finance can, in fact, be resistant to eliminating the year-end physical inventory. You must work with your finance leaders to convince them that your cycle count program will meet their needs.

Two things can overcome this resistance: Education and demonstration. Start by educating Finance about the problems inherent in the full physical inventory process and the many benefits of a cycle count program. Focus in primarily on the benefits to them: Better accuracy, more reliable values and fewer year-end surprises. Show them how the inventory will be counted more frequently under this program. Most successful programs count items using the "ABC" approach where A items are counted at least quarterly, B items twice a year, and C items once. This way you will count the full value of the inventory over three times.

Then suggest a trial program. Put together a formal proposal with a written policy and procedure on how the program will be managed. (A sample policy and supporting forms are available in the "Materials Management Policy and Procedure Manual.") Establish the criteria that will be used to measure success. Try to get agreement that, if the trial is successful, the cycle count program will become permanent and you will eliminate the year-end physical. Then perform.

In setting up your program one of the most important aspects is regular reporting of your results to Finance. There are two elements you should report every month.

The first is the results of the cycle counts. This should be a summary of the number of lines counted and the net dollar variance that was adjusted. It is also good to show what percent of total lines were counted, the percent of lines counted to date, the percent of inventory value adjusted (based on the value of the lines counted), and the cumulative percent of the inventory value adjusted.

The second element to report is your end of month value of the inventory according to your inventory system. Finance should compare this to the GL, adjust the GL as necessary to match your system and send you notification of what adjustment was made. You should track these adjustments from month to month to see if any pattern emerges.

Approaching Finance in this way with education, reporting and results has proved successful in virtually every case. After several months of consistent reporting and a reasonably accurate result, Finance will acknowledge the benefits of the cycle count program and acquiesce to eliminating the year-end.

Cycle counting is a best practice that every organization can adopt. You will have a more accurate inventory without the stress of the full inventory. Finance will be pleased, your staff will be pleased and your customers will be better served.