Inventory Audits

An Introductory Guide to Inventory Audits: Benefits & Procedures

By Team TranZact | Published on Mar 13, 2024

Inventory audits take time and effort, but they give a detailed look into a business's finances and money management. Understanding the steps involved in inventory audits is important for successful inventory management.

In this blog post, we'll understand the importance of performing inventory audit procedures for your manufacturing business and the advantages they offer. We will also see how audits can help improve your operations and reduce losses.

What is an Inventory Audit?

An inventory audit is when a business checks its actual inventory against its financial records to make sure everything is correct. This can be done by the business itself or by someone from outside. It is the process of making sure the records match what's actually in stock.

The inventory audit process involves employees going through every item in the warehouse, sometimes using inventory management software to help. Other times, it's more complicated and involves hiring someone else to look at all the businesses' inventory processes to spot any problems like theft or damage.

Importance of Auditing Inventory

Auditing inventory is important for many reasons. Here are some of the reasons why it should be performed:

1. Correct Financial Reporting

Inventory audits make sure that a business's financial statements correctly represent the inventory value on hand. This is important for meeting regulatory requirements and providing stakeholders with up-to-date financial information.

2. Cost Control

By doing Inventory count audits, manufacturing businesses can identify gaps between recorded and actual inventory levels. This helps control costs by reducing the risk of overstocking or stockouts. It increases inventory turnover and reduces storage expenses.

3. Quality Control

Inventory audits help manufacturing businesses maintain product quality by spotting any damaged or expired goods. Businesses can protect their reputation by delivering high-quality products to customers by quickly finding and removing defective items from inventory.

4. Fraud Prevention

Regular inventory audits protect against theft and fraud within manufacturing facilities. By tracking inventory levels and errors, businesses can uncover theft, mismanagement, or unauthorized access to inventory.

10 Common Inventory Audit Procedures to Follow

Following the correct inventory counting methods or procedures is important while auditing the inventory. Here are 10 most common procedures that you can follow to do an inventory audit

1. Cutoff Analysis

In cutoff analysis, operations like receiving and shipping are temporarily shut down during inventory audits to verify accurate counts. It is also important for the management to communicate with stakeholders in advance. This helps them manage expectations if delays occur in the operations due to the audit.

2. Analytical Procedures

Analytical procedures include comparing data like gross margins, inventory turnover ratios, and unit costs across different periods. It provides information on inventory trends. This helps in procurement decisions and demand forecasting.

3. Physical Inventory Count

Each unit is physically counted to verify the difference between recorded and actual stock levels. This can be done manually or with technology like barcode scanners. It helps in demand forecasting, decreasing stockouts, and controlling inventory shortages.

4. ABC Analysis

In ABC analysis, items are organized by value and volume (high, medium, low). It allows businesses to focus on inventory management efforts. In this procedure, the attention is typically focused on high-value items to improve inventory management and restocking decisions.

5. Finished Goods Cost Analysis

Finished goods cost analysis is important for businesses manufacturing their own products. This analysis calculates the value of finished goods ready for sale. It helps set prices for goods and reduce inventory storage costs.

6. Freight Cost Analysis

This involves calculating the expenses of transporting inventory. This includes freight shipping costs and tracking shipment times. It also covers any items that are being transported and items that get lost or damaged while being shipped. Doing this helps you decide if you're spending too much on shipping.

7. Reconciling Items

Reconciling items means fixing mismatches between physical counts and inventory records. It includes reviewing shipment and sales details. Therefore, creating a reconciliation statement helps correct inventory records and discover the root cause.

8. Overhead Analysis

Examining overhead/indirect expenses like rent, insurance, utilities, and administrative costs provides insights into overall business expenses beyond direct materials and labour. This understanding is useful in budgeting and improving profits.

9. Matching Invoices to the Shipping Log

Checking if the purchase orders or invoices match with shipping logs guarantees accurate billing and order fulfilment. This process helps avoid errors and improve order accuracy and customer satisfaction.

10. Direct Labor Analysis

This involves checking if the cost of labour used in production is included in the inventory cost. They do this by tracking the labour recorded on timesheets to confirm it matches the inventory cost.

How to Conduct Inventory Audit?

There are different inventory counting methods that help conduct a smooth auditing process. Here are some ways to do an inventory audit:

  • ABC Analysis: Sort products into high-value and low-value groups to help decide which ones to audit first.
  • Match Invoices to Shipping Log: Check if invoices match the number and cost of products shipped from suppliers or warehouses.
  • Physical Count: Count each item in the warehouse and write down what you find.
  • Inventory in Transit Analysis: Keep track of how long it takes for products to arrive when moving them between places.
  • Inventory Valuation: Figure out how much the unsold inventory is worth.
  • Inventory Obsolescence Analysis: Look at whether there's too much inventory that's not selling.

Key Challenges of Performing An Inventory Audit

Audit inventory control can be tricky and can have some challenges. Here are some big challenges that inventory audits can commonly have:

1. Hard to Handle

The bigger your business gets, the harder it is to manage inventory. Doing spot checks on some products can help sometimes. But ultimately, you'll need a smart Inventory management system as your business grows. This will help you keep things organized.

2. Time-Consuming

Checking physical inventory against electronic records is slow and time-consuming. It can take a long time, even if you have just one product with many units. To overcome this issue, using electronic reports can help save time. This will give you quick updates on inventory.

3. Operational Disturbances

Doing inventory audits can stop your regular work, like filling orders and shipping orders. This can make customers unhappy. To deal with this, you need to balance doing audits and keeping things running smoothly. Using TranZact inventory audit software can help reduce this problem.

Inventory Management Audit Checklist

Here's a simple inventory audit checklist that you can follow while performing your next audit:

  • If you're hiring someone from outside to do the audit, give them all the information they need.
  • Pick a time when your business is not very busy.
  • Use a good software that helps you track inventory in real-time and make reports.
  • Write down what you find during the audit.
  • Follow the right steps for the audit, like counting everything, checking for any missing items, and looking at shipping costs.
  • If you find any differences between what you expected and what you found, figure out why.

Best Practices for Smoother Inventory Auditing

Here are some best practices for carrying out a smoother audit that will help promote inventory internal controls:

  • Choose what to audit: Before performing the audit, decide which inventory items are most important to check.
  • Prepare your documents: It is important to have inventory records, shipping reports, invoices, and proof of ownership prepared for the audits.
  • Do audits regularly: Aim to do the audits at least once or twice a year or even quarterly.
  • Stay neutral: Consider using an external auditor for a third-party view.
  • Share the results: Once the audit is done, share findings with stakeholders and keep a record for reference.

Maximize Audit Efficiency and Accuracy With the Right Inventory Management Software

Using the right inventory management software can greatly improve audit speed and quality. This software can speed up the inventory tracking processes. They also reduce errors and keep records up-to-date. By providing easy access to inventory information, an inventory management tool can help businesses manage audits easily and with greater confidence.

Perform Quick Inventory Audits With TranZact

TranZact is a tool for small manufacturing businesses to help them go digital in their inventory operations. Using TranZact for internal audit of inventory management process allows manufacturing businesses to perform detailed and timely audits. With this tool, manufacturers can easily track their inventory, improve stock levels, and avoid theft. This approach helps improve audit procedures, saving time and increasing accuracy in inventory management.

FAQs on Inventory Audits

1. What is the purpose of an inventory audit?

The purpose of an inventory audit is to check and verify that a business's physical inventory matches the inventory records. This helps maintain the reliability and accuracy of financial statements and helps detect any errors in inventory management.

2. What is the difference between a physical inventory and inventory audit?

A physical inventory involves physically counting and recording all items in stock at a specific time. On the other hand, an inventory audit involves verifying the accuracy of inventory records by comparing physical counts to recorded amounts.

3. What are the risks and challenges associated with inventory audits?

Risks and challenges associated with inventory audits include:

  • Time-consuming nature
  • Potential for errors in manual counting
  • Difficulty in coordinating audits with ongoing operations
  • Need for accurate documentation and record-keeping

4. What is the 5 step audit process?

The audit process involves five steps:

  • Planning the audit
  • Conducting pre-audit risk assessment
  • Performing audit procedures
  • Evaluating audit findings
  • Issuing the audit report

5. How often should inventory be audited?

Inventory should ideally be audited regularly to maintain accuracy and legality. Business size, industry regulations, and risk factors may affect how often audits are conducted. Generally, the audit of inventory management is conducted at least once or twice a year.

6. What is the audit procedure for inventory?

The audit procedure for inventory includes reviewing inventory records, conducting physical counts, reconciling errors between physical counts and recorded amounts, checking internal controls related to inventory management, and checking the accuracy of inventory valuation methods.

7. What are the audit concerns with inventory?

Audit concerns with inventory focus on accuracy, valuation, existence, completeness, and presentation and disclosure of inventory in financial statements. These concerns guarantee that inventory is correctly accounted for and reported in financial statements.

8. How to check the minimum level of inventory in an audit?

Auditors can review inventory reorder points, historical sales data, demand forecasts, and inventory turnover ratios to check minimum inventory levels in an audit. They assess whether inventory levels meet customer demand while reducing carrying costs and stockouts.

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TranZact is a team of IIT & IIM graduates who have developed a GST compliant, cloud-based, inventory management software for SME manufacturers. It digitizes your entire business operations, right from customer inquiry to dispatch. This also streamlines your Inventory, Purchase, Sales & Quotation management processes in a hassle-free user-friendly manner. The software is free to signup and gets implemented within a week.