The year-end is rapidly approaching, which means it’s almost time for your annual physical inventory. For manufacturing, retail, and distribution companies, physical inventories are a necessary part of business. Accurate insight into the quantity, cost, and net realizable value of inventory is essential not only for operational decision-making but also for meeting financial reporting requirements. Additionally, when a company’s financial statements are audited by a Certified Public Accountant (“CPA”), generally accepted auditing standards require auditors to observe the physical inventory at year-end. Given these requirements, proper planning is critical to executing a complete and accurate physical inventory count.
Below are ten steps to help you plan and execute a successful physical inventory:
Choose the date and time when inventory movement will be minimal. When selecting a date, consider factors such as whether a temporary plant shutdown is feasible, or whether performing counts on a weekend or holiday will incur additional payroll or overtime costs.
Clear communication before the count is essential. Proper planning, timing and organization help ensure an efficient and accurate process. Hold an internal meeting beforehand so all team members understand the counting procedures and their specific responsibilities.
Management should consider developing written inventory instructions and distributing them to all team members involved in the count. Provide a copy to your CPA in advance as well. In some cases, auditors may request a walkthrough of the warehouse prior to the physical inventory date.
With AI transforming business operations, companies may benefit from using AI tools to support inventory planning. Ask your AI tool strategic questions, phrased in different ways, to uncover tips, efficiencies, and planning considerations that may streamline your approach.
Perhaps the most impactful step is organizing the warehouse ahead of the count. Separate loose items from bulk, minimize work-in-process inventory where possible, and set aside staged shipments and receipts. Clearly mark slow-moving, obsolete, or damaged items. Keep customer- or supplier-owned inventory segregated, and account for items stored in freezers, containers, or third-party locations. Consider pre-counting low-movement items to reduce time on count day. A cluttered environment increases the risk of errors and often leads to costly, multi-day counts.
Decide whether to use pre-numbered tags, barcode scanners, manual count sheets, or another documentation method. Assign responsibility for tag control and ensure all unused, voided, or damaged tags are tracked. If using manual sheets, put procedures in place to ensure completeness and prevent double counting.
Ensure all team members arrive on time and assign supervisors to specific areas. Use at least one, and ideally two, counters per area. Blind counts are strongly recommended. Maintaining proper cutoff is critical—any incoming or outgoing inventory on the count date should be tracked separately.
After counts are submitted, the tag control employee should reconcile them against the pre-count inventory listing. Investigate variances and perform recounts when necessary. Supervisors should walk the warehouse to confirm no items were missed. Management should approve final variances, and adjustments should be recorded in the inventory subledger. Be sure to account for inventory in transit. If the count is not performed at year-end, a rollforward will likely be needed to reconcile to the general ledger. Maintain secure offsite backups of inventory data before and after the count.
Regular cycle counts throughout the year demonstrate strong internal controls. They reinforce warehouse organization, allow discrepancies to be corrected in real time, and reduce the magnitude of year-end book-to-physical adjustments.
Physical inventory day is demanding—team members may be operating forklifts, lifting boxes, and navigating long hours. A simple gesture like providing lunch can boost morale and create goodwill. I recall one of my clients bringing in a huge pot of homemade chili with all the fixings. The plant employees came in from the cold and snowy day to a bowl of delicious warm chili. After their lunch break the team went back out and the rest of the day finished without a hitch. A simple little act of employee appreciation goes a long way. The employees will give back twice as much, enjoy a little team bonding and perhaps have a little fun while they are at it.
With thoughtful preparation, clear communication, and a well-organized warehouse, your physical inventory can be completed efficiently and accurately. Use the year-end process not only as a compliance requirement but also as an opportunity to strengthen internal controls, improve warehouse operations, and reinforce team engagement. A well-executed physical count sets the stage for better decision-making and a more productive year ahead.
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