The end of a fiscal year is an exciting time for most organizations. Among other things, there is a push to collect receivables, pay vendors, evaluate accounting estimates and start planning for the next fiscal year. With an established cut-off date, the year-end financial statements provide a window into the successes and failures of the organization. It is safe to say that there is one particular component of year-end that most manufacturers dread: the inventory count!
Because the purchase and sales of goods cannot be interrupted during these procedures, the inventory process can be difficult to coordinate. Instead of counting inventory periodically, manufacturers should explore the opportunities with adopting cycle counting.
Cycle counting is the process of counting a partial amount of an organization’s inventory on a frequent basis, usually daily or weekly. Here are some of the advantages:
- Less Disruptive
Since an organization is counting a small batch of inventory at a time, all shipping, receiving and manufacturing processes can operate without interruptions. Variances and errors can be adequately researched and resolved without the time constraints involved with disrupting operations and the high stress levels that exist at year-end.
- Increased Efficiency
Under cycle counting, errors are identified faster as inventory is being monitored on a more consistent basis. These inventory errors can be very costly to an organization and can be the cause of significant operations inefficiencies. The sooner an error is identified, the sooner an organization can react, therefore minimizing the corresponding effects. If the inventory is only counted in the last few days of a fiscal year, there is no time to make corrections that will impact the current reporting period. Cycle counting also leads to an additional level of operational efficiency since inventory must always be organized, properly tagged and all purchases and sales must be processed and closed out timely. Poor inventory management leads to over-buying and increased shipping charges. Cycle counting allows the operations department to rely heavily on the inventory records for ordering and production scheduling.
- Specialized Staff
Usually, with periodic counts, staff members that are not familiar with inventory items or the space they occupy are asked to help in order to speed up the process. This practice comes with its own inevitable risk of error. Also, at times it is even necessary to pay overtime to employees as the inventory counts take place during non-business hours. With cycle counting, organizations can create small, specially trained teams to perform these procedures during normal business hours. These teams will contain staff that are well versed in the manufacturing process and the corresponding inventory items. Over time, the members of these teams will become essential informants to management. Their daily or weekly involvement with inventory counting should be viewed as a valuable resource and tapped into when changes to operations are on the horizon (i.e. space planning, new product line, staff evaluation).
- Reduced Year-End Adjustments
Since inventory variances and errors are addressed throughout the year, it is less likely for significant adjustments at year-end. This increased accuracy in interim financial statements will keep management and users of the financial statements more informed.
The ‘ABC’ Method
The most common method of cycle counting, called the ABC method, involves segregating items into various count frequencies. This method was developed around the Pareto principle which states that 80% of the effects come from 20% of the causes.
Translated to cycle counting, an organization must determine which inventory items will be responsible for the majority of the errors and count them the most frequently. An organization’s total inventory needs to be broken down into three classes based on the value and number of inventory items:
- “A” Class
The first class will include the inventory items that are the most critical to operations and will be counted frequently throughout the year. These should include inventory items that are turned over often throughout the year or have high value (e. raw materials). After segregating these items, the organization should notice that these items will be made up of a small number of SKUs that comprise a high percentage of the organization’s cost of goods sold.
- “B” Class
The next class should include inventory items that are significant to operations but will be counted less frequently than the class described above. There will be a large number of SKUs with a total cost less than the “A” class items.
- “C” Class
The last class will include inventory items that have less movement and carry a lower value. These should include smaller components or supplies that are used in operations and will only be counted once or twice a year.
After determining how often inventory items should be counted, an organization will implement a counting schedule, determine staffing needs and develop and implement a tolerance threshold for investigating count variances. All cycle count procedures need to be properly documented and maintained throughout the year.
It is understandable that this process seems intimidating and expensive. An organization can gain experience with cycle counting without dropping periodic counting altogether. This can be accomplished by first segregating inventory as described above and then picking several times throughout the fiscal year to count the “A” items and exploring the information that is gained from that exercise.
Although a year-end physical count would still be necessary, the organization should notice a decrease in the amount of year-end adjustments. After the benefits of cycle counting have been realized and the staff becomes more familiar with the process, the organization can slowly start moving to a full cycle counting schedule.
For more information on the benefits and implementation of cycle counting, contact Amy Jackson at 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.