Inventory management is a pain, and rising consumer expectations driven by e-commerce are only making it harder. It’s no longer enough to have a well-run distribution strategy. In order to fulfill orders the same day or the next day, you have to know how to manage inventory across several locations. To further complicate the situation, customers may expect to be able to order online and pick up in-store.
Even if your business isn’t expansive enough to create retail “flow centers” like Target or redesign your entire supply chain like Brooks Brothers, it’s important to understand the fundamentals of inventory management.
Why? Well, for several reasons, like:
- Your inventory is the lifeblood of your company. Take good care of it. No inventory means no goods to sell and no money to make.
- Proper inventory management keeps you operationally efficient, limiting the time and money spent on carrying costs like rent, heating, security, labor, and insurance.
- Customers are unforgiving. If you’re routinely out of inventory - or fail to fulfill an order as promised - they’ll go to your competitors.
- Your business can’t grow sustainably without good fundamental processes.
In other words, in order to get to the level of giant retailers like Target and Brooks Brothers, you have to understand basic inventory hygiene.
Physical Inventory Counting and Cycle Counting
A critical activity of inventory control is inventory counting. Counting your goods to ensure the final number matches up with your purchase orders helps you identify instances of loss or theft.
Of course, inventory counts are a huge undertaking and, when poorly done, they lead to inaccuracies, which defeats the purpose of the entire exercise.
Inventory counting can be divided into two styles: physical inventory counting and ongoing basis cycle counting. While a physical inventory - the all-encompassing count of a business’s entire inventory - is a comprehensive approach, it’s not always feasible. More often than not, companies must stall or completely halt operations in order to take a proper count. Moreover, a physical count may not properly identify the reason for inventory inaccuracies - it can end up being an expensive way of identifying the problem.
Ongoing basis cycle counting is an effective alternative to physical counting. While cycle counts present many benefits, they can be complicated. A physical count is a straightforward endeavor. As long as you have a map of your warehouse, assign workers to specific areas, and provide them with sheets to take their counts, your only concern is human error.
On the other hand, a cycle count relies on sampling, which means if the methodology is rotten, the sample won’t be any good either.
Fortunately, once you break down cycle counting, it’s a relatively manageable process to understand and carry out.
Accounting and Operations: The Dual Purposes of Inventory Counts
Inventory counts happen for two purposes:
- Operational efficiency
The type of inventory counting method you pick will have pros and cons based on which purpose you prioritize. Ultimately, both purposes have one mega purpose - to protect the viability of the company. Categorically the former is concerned with value while the latter is concerned with service.
For example, your Chief Financial Officer may prefer the Pareto Method of cycle counting, which accounts for the value of goods, while your Chief Supply Chain Officer prefers cycle counting by usage only, which prioritizes goods that move most frequently regardless of value.
Understanding this difference will help you understand why different parties advocate for different methods. It’ll also help you make a decision about which approach is right for your business.
What Are The Different Types of Cycle Counting?
Inventory cycle counting differs from physical counting because it counts sections of inventory and uses those sections to make an inference about the accuracy of the warehouse’s entire stock. Physical counting is an all-encompassing total count of everything in stock.
There are three main types of cycle counting:
- ABC analysis cycle counting
- Process control group cycle counting
- Opportunity based cycle counting
ABC Analysis Cycle Counting
ABC analysis cycle counting relies on a class system. The inventory manager, or inventory control system, conducts a statistical analysis based on specific factors to identify Class A items, Class B items, and Class C items. The A items are counted more frequently than the B items which are counted more frequently than the C items.
The variables used to determine how items are classed depends on what’s important to the warehouse. Generally speaking, there are three different types of ABC analysis cycle counting:
Pareto Principle-Based ABC Analysis
The Pareto Principle states that 80 percent of outcomes are due to 20 percent of causes. A supply chain manager runs an analysis to find which products produce the most value for the company. This value is determined by multiplying the cost of an item by its usage per period.
From an accounting point of view, this method protects inventory value and, therefore, the overall value of the company. Nevertheless, focusing too heavily on Class A items can lead to inaccuracies in counts of lower-class items.
Usage-Based ABC Analysis
The more inventory moves around, the more chances there are for items to go missing. Because of this, some warehouses prefer to employ a usage-based approach to their ABC analysis. Instead of making Class A the exclusive home of high-value items, they rank their inventory based on how frequently it moves. Therefore, if customers order a product often, even if it isn’t all that expensive, it’ll be counted more frequently.
The idea here is that these are the areas where inventory inaccuracies are more likely so, therefore, these are the areas that should have the most counts. From an operational point of view, this is a good approach. Multiple upset customers are harder to deal with than one upset customer, so ensuring your popular items are always on hand is smart. That said, from a financial point of view, failing to properly account for high-value items can be detrimental to the business.
Hybrid ABC Analysis
This approach incorporates the best of two worlds: automated statistical analysis and experiential adjustments.
As a starting point, the hybrid method uses the Pareto Principle to determine which items are generating the most value in your supply chain. This division of goods is not set in stone. Rather, the supply chain management team can adjust the classifications based on their observations.
This can be an advantageous approach if the classifications are only changed by specific individuals and after meeting certain criteria. Otherwise, there’s the risk that statistical methods will be completely abandoned for “gut feeling” adjustments that aren’t based on real data.
Process Control Cycle Counting
This method lets counters decide which sections they want to count. Counters look at the current inventory record to see if there are any discrepancies and, if there are any issues, they conduct a count.
According to the academic literature on process control counting, it is “controversial in theory, [but] effective in practice”. This is because, at first glance, employees can simply choose the easiest inventory to count and skip difficult inventory by relying on the existing record, if they wished. In practice, a review of the method found that while statistically the process control method is biased, in practice it’s biased towards inventory items with the highest chance of inventory inaccuracy, and these are the sections a warehouse wants to focus its attention on anyway.
Opportunity-based Cycle Counting
Opportunity-based cycle counting conducts inventory checks at key points in the inventory management process. Instances in which an opportunity-based cycle count may be conducted are when:
- An item is reordered
- An item is stowed
- An item’s balance drops below a predetermined threshold
The success of this method ultimately rests on how carefully a warehouse sets its “decision parameters.”
What Are Cycle Counting Best Practices?
Without question, a cycle count sounds incredibly convenient. Who wants to shut down operations for a day when you can count while you work? But you also don’t want your cycle counting efforts to be purely ceremonial. What you’re aiming for is a process that helps you identify and eradicate inventory control issues. To do so, keep the following cycle counting best practices in mind.
Ensure Your Inventory Data is Up-to-Date
If you receive new inventory, be sure to enter it into your system. You’ll need accurate, up-to-date information if you want your cycle count to be a productive exercise. If you really dread the task of manual data entry, there’s technology that allows warehouses and retailers to automatically upload inventory data from their suppliers.
An Annual Physical Inventory Count
Cycle counting doesn’t eliminate the need for a physical inventory count - it just helps you maintain your inventory’s hygiene until the next big pass. If you haven’t been keeping up with your inventory management at all, don’t go straight into cycle counting. Conduct a physical inventory count so you have an inventory accuracy starting point.
Some companies have such tight procedures that their goal is to completely eradicate annual inventory counts and stick to continuous cycle counts. Unless your inventory accuracy is consistently above 95 percent, it’s best to keep your annual inventory count on the calendar.
Schedule Regular Cycle Counts
By nature, cycle counts are not a one-and-done proposition. They must be conducted routinely. While some operations conduct daily counts for specific SKUs, your bare minimum should be a quarterly cycle count (depending on the size of the count) with a goal towards a weekly count.
Putting it in the calendar - and sticking to it no matter what - will help embed the practice into your business’s standard operating procedures.
Prioritize Rather Than Eliminate Cycle Counts
Don’t have the resources to conduct your cycle count as planned? Don’t eliminate a scheduled count; simply prioritize. If you use an ABC analysis method, this will be rather straightforward since you’ll have the data and established hierarchy already. Otherwise, identify what the priority areas or trouble areas are and focus on those.
Randomly Alternate Between Counting Staff
Randomly alternating between counting staff limits the chances of theft or coordinated attempts to rig the count. That said, balance the need for loss prevention with risk management. Introducing inexperienced staff to the count can lead to losses in other ways.
For instance, inexperienced staff may not know how to use specific software or operate forklifts to count by weighing., Experienced counters will know how to navigate the warehouse and work more quickly and efficiently.
Automating the Cycle Counting Process
Inventory management systems are either manual or automatic. While many small- to medium-sized businesses employ manual or semi-manual inventory management processes, an increasing number of them are moving toward automated inventory management. As for large companies, you’d be hard pressed to find a physical count sheet anywhere in sight.
Typically, retailers or warehouse owners would have to manually upload inventory data to their system. With an inventory management system (IMS), data is transferred straight from the supplier’s system to your own. When conducting a cycle count, it’s important to ensure your inventory data is up-to-date. Otherwise, your entire efforts are undermined. With an IMS, data is automatically updated, furthering your inventory management efforts.
Instead of handing your workers pens and count sheets, consider giving them mobile scanners. Here’s how it works: Each item has a barcode. A worker scans the barcode and the information from the barcode is fed into the inventory management system. Not only is the count conducted automatically, but management can also easily pull a CSV file from the system if they need specific information.
In addition, mobile scanners make real-time inventory management easier. If RFID is used, this competency is further enhanced.
While we’re still a little ways away from the widespread adoption of robot counters, it is something for inventory managers and supply chain professionals to keep an eye on. Walmart has started testing robots for inventory monitoring tasks in its stores.
Cycle Counting is Part of Your Inventory Management Hygiene
Inventory management may feel like a curse, but cycle counting is a blessing. While comprehensive, physical counts provide an excellent overview of your warehouse’s inventory accuracy, they are disruptive and not something that businesses can feasibly do regularly. Cycle counting allows you to check on the health of your inventory control processes throughout the year. You can ensure you have what you need on hand to keep your customers happy and protect your bottom line.
Written by Ruthie Bowles
Ruthie is a content marketing consultant for Logiwa. Her specialties include small business development and inventory management.