Wholesale
& Manufacturing Industry Update - Fall 1999 How Accurate Are Your Inventory Records? WHO is interested in inventory accuracy? Inventory personnel and sales staff rely heavily on the accuracy of inventory records. Inventory personnel need accurate records to adequately plan the production process. If a certain quantity of item "A" is being manufactured, and it needs items "B" and "C" for the production process, inaccurate on-hand quantities of items "B" and "C" will cause production stoppage. Inaccurate inventory records also impact the sales staff. If they promise a customer a certain quantity of an item based on the inventory on-hand records and those records are inaccurate, customer service decreases. Management, specifically accounting, also relies heavily on the accuracy of inventory records. Their focus of inventory accuracy is allocating dollar values to inventory. Although this is extremely important on the financial side of things, there are problems with looking at inventory accuracy in this way. Individual item differences can hide and cause production or distribution nightmares. If the inventory records and physical counts indicate that there is $500,000 of inventory on hand, accounting sees inventory as accurate. However, this does not necessarily translate back to correct on-hand quantities. WHY is inventory accuracy important? Are your sales people afraid to rely on the inventory records? Does your inventory manager over-stock because he/she can’t trust the numbers? Inventory and its accuracy are very important to the continued operations and success of a distributor or a manufacturer. Accurate records provide a company reliable information to plan for the long and short-term. However, inaccurate records impact the amount of time spent on annual physical inventory counts or cycle counting. The accumulation of inaccurate records throughout the year adds a significant amount of time to the reconciliation process as differences are identified and resolved. These differences can have a major impact on the bottom line. Nonetheless, many companies don’t realize the importance of accurate records and don’t understand how to measure accuracy. The following explanation highlights how to measure accuracy and the factors involved. HOW does your company measure accuracy? Overall inventory accuracy can be measured by the following equation:
It is important to note that an inventory record can still be considered accurate while having a certain level of inaccuracy. Inaccuracy maybe acceptable because the focus is on what items are significant and ensuring that they are correct. Establishing error tolerances for individual inventory items will provide a meaningful measurement of inventory accuracy. This allows inventory accuracy to be gauged within an acceptable means. Tolerance can be based on five factors: (1) an inventory item’s lead-time to acquire, (2) the amount of usage, (3) the dollar value, (4) the importance or (5) the method of handling.
Establishing Tolerance Levels As a general rule, an item’s usage should be the main factor in establishing its tolerance level. The higher an items usage, the greater the tolerance level will be. But, if this item also has a high dollar value, the tolerance should be tightened more closely to zero. Usage and dollar values are more likely to impact inventory the most in terms of inaccuracies. Lead-time and an item’s relative importance can also be factors in assigning tolerances. The longer the lead-time or the more important an item, the tighter the tolerance should be. Another method in assigning tolerances is to analyze the method of handling. The more "hands-on" the item is controlled in receiving and shipping of inventory, the lower the tolerance should be. For example, if the item is taken out of inventory one at a time it should have a low tolerance. On the other hand, if the item is taken out of inventory in bulk, say for instance by weight, it should be given a higher tolerance. A great amount of time could be spent analyzing what is a low or high tolerance item. Companies wanting to analyze inventory accuracy in this manner could use a simpler approach by using a ± 5 percent tolerance level across the board on all of its items. Once a company gets started, they can adjust their tolerances based on what they deem necessary by focusing on items that are more significant to its continued operations. The following table shows a sample company’s inventory counts and assigned tolerances. Looking at the table, there is 80% accuracy (4 accurate records ¸ 5 total records).
This analysis of accuracy is most effective when used with cycle counting. Using the annual physical inventory count to look at accuracy in this manner doesn't really supply the proper feedback to inventory or management personnel, especially if accuracy won't be examined again for another year at the next physical count. It is best to use the above inventory accuracy analysis after an overall system of inventory procedures has been designed and implemented and the initial inventory balances have been determined to be correct. From there, cycle counting can be appropriately employed along with its related analysis of inventory accuracy. When establishing these tolerances, it is essential to understand that accuracy is not an absolute. Accuracy is looked at with a greater or lesser amount of exactness depending on the particular item and its overall significance to the company. Once a method of analyzing inventory accuracy is in place, the company can adequately rely on its inventory counts and plan for the future. The company will benefit by streamlining the production process, increasing customer service through decreased stock-outs, and helping maintain a healthy and correct bottom line. Jennifer Lilly, CPA Inventory Group |