Inventory Record Accuracy (#56)
/In this podcast episode, we discuss the actions you need to take in order to achieve a high level of inventory record accuracy. Key points made are noted below.
Requirements for Excellent Inventory Record Accuracy
For lots of accountants, it’s pretty difficult to close the books when you’re not sure at all about inventory record accuracy. In some cases, I’ve seen controllers insist on a complete manual count of the entire inventory every single month – because they just don’t trust the system. So, let’s create a system that works. To do this, you need to address four main areas which are: the software, the rack layout, initial counts, and ongoing counts.
Inventory Tracking Software
For the first area, you need inventory tracking software that tracks inventory by bin location, and preferably for multiple bin locations. Also, it must update records immediately, not in a batch. If it’s in batch mode, then records will be inaccurate until you run a batch update, and that’s not acceptable. If you don’t have software with these two features, then stop everything and buy some that does.
And by the way, there are software packages with many more features than that, going up to ultra-complex warehouse management systems. But if you don’t have those two features, then you’re basically doomed.
The Inventory Rack Layout
Now let’s go to the second area, which is the rack layout. The first step here is to fix the physical layout of the storage racks. There’re lots of issues to consider, like leaving aisle room for forklifts, and clustering racks for small parts in one place, and storing slow-moving items in the back. This is a surprisingly technical area, so you might want to consider hiring a consultant who can design it for you.
Once the rack layout is set up, you need to create rack locations.
Location codes are usually in at least three parts, with a letter for the first part that designates the aisle, then a two-digit number for the rack within the aisle, and then a letter for the level within each rack on each aisle.
That sounds complicated, but it’s not. For example, C-17-B means that you’re in aisle C, rack 17, level B.
Now, as you walk down an aisle, the rack numbers should offset each other on each side of the aisle. For example, you start off with rack 1 on the left side of the aisle, then rack 2 on the right side, and then rack 3 on the left side. By numbering racks like this, inventory pickers can pick from both sides of the aisle as they walk down it.
Once you have the racks labeled, go back and create permanent labels with a bar code and the alphanumeric code side-by-side on the same label. Make you print out the bar code format that’s used by your bar code scanners. Then, put a clear plastic laminate over the labels, so there’s less chance they’ll be damaged. And by the way, forklifts damage these labels all the time, so have a weekly procedure to replace whichever ones are no longer readable.
The Initial Inventory Counts
OK, let’s move to the third major area, which is initial inventory counts. The goal here is to put the inventory into a fairly well organized system, so that you can then launch the ongoing counts in a reasonably efficient manner.
The first step for initial counts is to keep the inventory from being screwed up any further, and that means locking down the warehouse. Yes, people do come in and take items of the shelf, and they don’t record the deductions. They also take items from one shelf and then put them back somewhere else, which also does not help the record accuracy. So, you need to lock them out completely, with a fence and a lock on the gate. If this seems like overkill, please keep in mind that I’ve taken four inventory systems up to at least 98% accuracy, and each one of them had no chance until we installed the fence.
Now that things are safely locked up, you need to consolidate the same parts into one place. This makes it much easier to count them later. You will not complete this in one shot, because the same inventory item might be stored in a dozen places, and you won’t find them all on the first try.
Next up, have some experienced people who know the parts assign part numbers to everything. Absolutely never use an inexperienced person to assign part numbers, because they will screw it up. It might even make sense to use teams of two, so they can cross-check each other.
After that, have the same experienced people verify the units of measure on the parts. Put the correct unit of measure on the same inventory tag that contains the part number, so it’s all in one place.
Then you have to pack the parts. This means putting them in containers, then sealing the containers, and then labeling them with the part number, unit of measure, and number of units that are stored inside. Also, leave a few loose parts for immediate use. By doing this, it’s vastly easier for the warehouse staff to count parts later on.
After that, conduct an initial count, and drop all of this information into the inventory database. Once again, only allow experienced people to do this count. Any manager who allows the front office staff to count inventory should be shot. An inventory count is more difficult than you think, so keep non-warehouse people off the premises.
That completes the third phase, which gives us the tools for an accurate inventory – but it isn’t accurate yet. To do that, we need ongoing inventory counts, which are known as cycle counts. And that is the final phase.
Ongoing Inventory Counts
To do ongoing counts, first train the warehouse staff in how to cycle count. This means that they need to know how to run reports, do counts from the reports, and investigate variances. And in case I haven’t said it before, cycle counting should only be done by experienced warehouse personnel.
Once everyone is trained, start cycle counting. In brief, this means you print out a portion of the inventory list, sorted by location, and then match the report to the actual inventory. To do so, the counter should review a complete block of inventory, such as a couple of side-by-side racks. When doing the count, the employee matches the information on the report to what he sees on the shelf. In addition, he matches what he sees on the shelf to what is on the report.
Please note: These are two separate activities.
Everyone counts from the report to the shelf, but by also tracing from the shelf to the report, you spot inventory that’s not recorded in the inventory database at all. Managers like this extra count, since it increases inventory, and therefore reduces the cost of goods sold.
The frequency of cycle counting varies by company. For a high-volume warehouse, you might need to cycle through the entire thing once a month. Or, if some of it is slow-moving, once a year might be enough. Or, keep recounting items that are always running out, or that are the most expensive.
Now, here’s the key part. Whenever a cycle counter finds a mistake – and he’ll find lots of them at first – he doesn’t just go to the inventory database and update the record with the correct number. The real trick is to have them investigate why the error occurred, and make sure that it doesn’t happen again. To get to this level of investigation, the warehouse manager really needs to buy into the whole inventory accuracy concept, because this will chew up lots of cycle counter time, especially during the first few months.
The Need for Inventory Auditing
At this point, the system is in place, but I’ll guarantee you that it will not work as well as you’d like. The reason is that the warehouse staff does not yet understand the importance of cycle counting, so they tend to let it slide. Here’s what I do. I have someone audit a small part of the warehouse once a week, and post the results on a white board in the warehouse. We also assign specific aisles to cycle counters, so that we can post accuracy information by employee. If any counters are having really good accuracy results, then we hand out a small bonus on the spot.
That’s the carrot part of the equation. The stick part is that the warehouse manager’s performance is partially based on the overall accuracy of the inventory – so he may not do too well if he doesn’t meet his accuracy targets.
That covers the process. However, if you think this’ll give you a fabulously accurate inventory in a few weeks – think again. There are likely to be a couple of dozen procedural problems that are causing inaccurate inventory, so until the cycle counters discover and correct each one of them, the accuracy will not be good enough. So, based on my own experience, I can safely say that you need to budget a minimum of six months to achieve really high-grade inventory accuracy, which I consider to be 98%.