Physical Inventory

Years ago, as a young junior auditor I was assigned to test count the parts inventory at an Otis Elevator plant in Bloomington, Indiana. The supervisor in charge of the area was leaving for a fishing vacation as soon as I released his section. I did a few test counts and compared my counts with his. All differed. The inventory was not well sorted, stacked here and there, counts were sloppy. He was ordered by the plant manager to rearrange all of the parts in to better order, and recount. It took another day. He missed the weekend fishing trip. Not a good way for a junior auditor to win friends and influence people. But it had to be done.

Physical inventory taking can be expensive, time consuming, and if not done right, unpleasant. See above. For mid market companies like my clients ($2 million to $20 million in revenue) it often seems like a waste. Even if the banks don’t require it, you should routinely take physical inventories and compare with the accounting records.

First, it is a good check on the plant or store personnel. If never checked, people tend to get sloppy, if not fall in to outright theft. If they know you will check, behaviors change.

Second, it is critical to find out if the accounting system, which tracks quantity and price, is accurate. Much of the time it is not, and it is the accounting system that is in error. One of my clients bought several hundred thousand dollars worth of precious metal that was used in its manufacturing process. Three weeks later they took a physical inventory. We compared the result with the newly designed accounting system (I had designed it). We were off more than $30,000 (10% of the entire inventory we had purchased), in less than a three week period, during what was generally a low volume cycle. Either my accounting system was horrible, we did not acquire as much metal as we thought, somebody stole, or the counts were poorly done. The owner personally did a recount and reweigh of the metal. Indeed, the physical inventory was not counted right. Good news for my client because there weren’t $30,000 in losses, real good news for me because the accounting system worked, bad news for the guys in the plant.

Third, when you take physical inventories, it credentials your management and stewardship. That’s critical to the bank. One of my clients and I personally conducted a physical inventory on January 1, New Years Day, in below zero weather. We counted hogs and newborn pigs outdoors and in their crates. The livestock secured the farm loan. We did not have to take an inventory on January 1, in that horrible weather. But, the fact that we did it personally, and had it audited, was an important validation of our stewardship for the bank.

Last, it does not have to be all that expensive and time consuming. Plan it out, take the physical when quantities on hand are seasonally low, count and price accurately, and call it a day.

Then go fishing.