How to Reconcile Your Inventory in 6 Steps (2024)

Cover illustration; a merchant sits atop a giant abacus, gleefully pointing to their clipboard.

As a retail business owner, you deal with countless moving parts, including customers, employees, money, and inventory.

Whatever your inventory situation is–whether you only have a few hot items that sell well or all your inventory is flying off the shelves–there are most likely inventory records in your point-of-sale (POS) system that don’t match the amount of physical stock you have in store. 

This calls for inventory reconciliation: comparing your inventory records to your actual stock levels and accounting for the differences. Although essential to avoid stockouts, this process takes time that would otherwise be focused on your customers and making sales.

But does inventory reconciliation have to be a major interruption to business? No, and we’ll tell you why, as well as how you can keep your sales flowing in.

What is inventory reconciliation?

As noted, inventory reconciliation involves checking your physical inventory data against your inventory accounting record to make sure the record is accurate. Simply put, the number of units your inventory management system has on record should match what you physically have on your sales floor and/or in your stockroom and warehouse.

Inventory reconciliation can be a challenge. Counting all your stock and cross-referencing the results of your count with the inventory levels in your POS system takes organization, commitment, and willingness to dedicate the appropriate amount of time to the task at hand. Follow these six steps to get the job done:

1. Choose your inventory reconciliation method 

The best way to reconcile your retail inventory? That depends on your business needs. Here are three basic methods that leverage cycle counting, an essential component of inventory management.

ABC method

Also known as the Pareto Principle, or 80/20 rule, the ABC method organizes your inventory by the percentage of your total revenue particular products represent. 

  • A-grade inventory. Products that account for 80% of your revenue. 
  • B-grade inventory. Products that account for 15% of your revenue. 
  • C-grade inventory. Products that account for 5% of your revenue. 

Since it provides most of your revenue, when using the ABC method, count your A-grade inventory more often to make sure you always have stock on hand. For example, you might count Group A inventory monthly, Group B inventory every four months, and Group C every six months. 

Seasonal method

Businesses strongly affected by seasonality, however, might want to perform inventory counts based seasonal demand.

Let’s say you’re a sporting goods store. Using the seasonal method, you’d count and reconcile your running shoe inventory prior to the spring/summer season (say, in February) and your winter boot inventory prior to the fall/winter season (say, in August). 

This method assures that your on-hand inventory count is accurate before you start forecasting demand for a particular product category, submitting purchase orders to suppliers, and restocking ahead of peak season.

Arbitrary method

Alternatively, instead of grouping and counting stock by the percentage of revenue it represents or by seasonality, you can go by how it’s organized in your store or categorized in your POS system. 

Or you might count and reconcile inventory on the first Monday of each month, or on whichever date your store typically processes the least transactions. This is known as the arbitrary method, in which the way you count inventory is not pre-defined based on a certain set of criteria, but is entirely up to you.

2. Count your physical inventory

Whatever approach you’re using, the first step in your inventory reconciliation process should be a full inventory count. This will give you an accurate picture of how much inventory you have for each product you carry in-store.

PRO TIP: If you’re using Shopify POS, select + Stocktake from the Stocky app to start a new inventory count. Enter a title for the stocktake (consider using the date, product type, and product category) and the store location where the count is being performed. Scan items using a barcode scanner, and inventory levels will be automatically recorded.

The amount of time it takes to count all of your inventory depends on how much inventory there is to count. Be sure to clean up your shop and organize your stockroom beforehand to make this step go as smoothly as possible. Depending on how many SKUs you carry, doing a physical inventory count might take a full day’s work to finish. 

Alternatively, consider cycle counting—a less time-consuming alternative to full inventory counts in which you count one category of inventory at a time, rather than everything at once. Cycle counting can help you avoid closing your store during business hours or scheduling an overnight shift to count inventory. 

3. Compare physical counts and digital records

Once you’ve finished counting your inventory, compare the total number of each item to the inventory levels for that product recorded in your POS system. 

Are you missing any items?

Inventory discrepancies (shrinkage) can be due to human error, administrative errors like mislabeling an item, supplier fraud, return fraud, employee theft, or shoplifting.

4. Identify missing items and the source of discrepancies

Now, dig deeper into the discrepancies you’ve identified. Do you have more or less of a certain size or style? Are you consistently seeing shrinkage with products from a particular supplier or brand? Look where shrinkage is happening and see if there are any patterns. 

Take a look at the missing items. Review your purchase orders, the inventory you received, and the sales you made between now and your previous reconciliation. Look for anything that doesn't add up: receiving too much or too little of an item when compared to your PO, misrecorded serial numbers, or mislabeled receipts or invoices, for example.

If you can’t trace back the source of shrinkage, you may be looking at a case of theft or fraud. Consider interviewing your employees, including those who work near the inventory where shrinkage is occurring. Have them be extra vigilant for shoplifters and routinely review security footage. 

5. Record discrepancies and reconcile your inventory

With or without knowing the source of shrinkage, you must create an inventory reconciliation report. This should compare the results of your inventory counts versus your recorded inventory levels, your shrinkage rate, and the total cost and retail value of shrinkage, as well as the total cost and retail value of your inventory on hand.

PRO TIP: If you’re using Shopify POS to reconcile inventory, use the Stocky app’s Stock Adjustments to change inventory levels for a product or SKU. Be sure to add notes to give staff context on the reason why you adjusted the amount of recorded inventory. Merchants have a historical view of each stock adjustment, can read notes associated with each adjustment, and see which of their staff performed the adjustment.

6. Routinely reconcile inventory

The last step is to make it a habit. Counting and reconciling inventory helps prevent your shrinkage rate from getting out of control. By counting and reconciling frequently, you’re assuring that the inventory reports you refer to for restocks, or the stock levels you show shoppers on your online store, are accurate.

Having accurate inventory levels helps you prevent understocking or overstocking, and enables you to fulfill as many orders as possible, both in-store and online. 

Inventory reconciliation example

Let’s review a hypothetical example of inventory reconciliation.

You have a women’s clothing store. Two of your bestselling products are skinny jeans and t-shirts. You’re getting ready to restock the sales floor, but before you do, you want to make sure the inventory amounts in your system match the physical inventory in your stockroom or warehouse.

A spreadsheet listing two products, their record counts and physical counts, along with the difference between the two and a checkbox indicating if the issue is reconciled.

You have 21 pairs of skinny jeans in your system, but you count 18 physical pairs at your warehouse—a -3 discrepancy. You have 32 t-shirt units in your system, but you count 36 physical t-shirts in your stockroom—a +4 discrepancy. 

In both cases, reconciling your inventory means updating your system to make sure the numbers match what you actually have on hand and available to sell. Once you’ve done this, you can mark off each item as “Reconciled”.

Benefits of performing regular inventory reconciliation

Reconciling inventory is essential to tracking inventory shrinkage rates over time. Iit shows you how much money you’ve sunk into lost inventory, and the revenue that inventory could have generated.

It ultimately helps assure that you have enough inventory on hand to meet customer demand, and to avoid preventable stockouts or overstocks resulting from inaccurate inventory levels in your POS system. 

The benefits of reconciliation include: 

Accurate inventory reports and data

Your inventory reports directly impact your business’ bottom line. You likely make a whole host of decisions that impact both cash flow and revenue based on this data, such as which items to reorder, run promotions for, or discount.

Reconciliation assures that your inventory data is accurate and that, by extension, the decisions you make based on that data are well informed.

You have 21 pairs of skinny jeans in your system, but you count 18 physical pairs at your warehouse—a -3 discrepancy. You have 32 t-shirt units in your system, but you count 36 physical t-shirts in your stockroom—a +4 discrepancy. 

In both cases, reconciling your inventory means updating your system to make sure the numbers match what you actually have on hand and available to sell. Once you’ve done this, you can mark off each item as “Reconciled”.

📚Also read: Beginning Inventory Formula: How To Value Inventory (2022)

Improved demand forecasting

Your customers expect your store to have inventory for the items you’re showcasing online. By reconciling often and assuring inventory levels are accurate, you’re more capable of restocking items before you run out of stock and can avoid the costs associated with unsold inventory at the end of a reporting period.

Adam Besheer at Greenery Unlimited agrees:

“We’re a multi-location business that is constantly moving inventory between our locations. Our inventory, in dealing with plants, happens to be complicated, because the same type of plant can come in many different shapes and forms depending on how it’s grown and by whom. Clean inventory numbers help us not only replenish our existing stock as needed but allow us to make more accurate predictions on how and when to replenish our inventory.”

Mitigated shrinkage risk 

Shrinkage is inventory loss caused by shoplifting, employee theft, fraud, or administrative errors. Ultimately, shrinkage represents a sunk cost—inventory you bought, but can no longer sell.

According to the National Retail Federation, in 2021, retail shrink was nearly a $100 billion problem, up from $90.8 billion in 2020—and organized retail crime (ORC) is one of the main drivers according to its 2022 National Retail Security Survey

Shrinkage rate refers to the percentage of inventory on hand that’s lost. Calculate your shrinkage rate after doing inventory counts to find the total cost and total retail value of that lost inventory. Aim for shrinkage rates as close to 0% as possible.

Calculate your shrink rate for a given period using the following formula:

Recorded Inventory Value - Actual Inventory Value / Sales x 100

While a shrink rate of 0% is ideal, every retailer faces some degree of shrinkage. Mitigate inventory loss by routinely counting your inventory and having a inventory loss prevention plan.

Updated safety stock levels 

Safety stock is a preventative measure where you stock extra inventory for certain items either to avoid stockouts or work around suppliers who are slow to fulfill purchase orders. While safety stock can be helpful, unnecessary overstocking eats into the cash you have available to spend on other inventory or expenses. 

Reconciliation helps you see what inventory is actually available to sell (ATS) and cross-reference that to each item’s historical sales velocity, which enables you to order safety stock only when it makes sense to do so.

Identify theft and fraud

You won’t know if you’re dealing with shoplifting, theft, or fraud without routinely counting your inventory and comparing the results with the inventory levels logged in your POS system. 

The act of counting inventory and seeing how much shrinkage you’re dealing with provides needed clarity on any discrepancies, can help you identify whether you have a theft or fraud issue—whether it’s internal or external—and take appropriate action. 

Inventory reconciliation tips

Regardless of how you choose to count and reconcile inventory, these best practices will make the process easier for you and your staff: 

Use inventory management software 

Pen and paper increase the likelihood of making preventable counting errors during a stocktake. Additionally, searching through paper records of inventory adjustments and keeping track of previous reconciliations is much more time-consuming than with digital records.

Use Shopify POS for inventory management

Consider using a POS system like Shopify, which comes equipped with inventory management software apps like Stocky to help count inventory (and view reports of past stock counts or adjustments) across each of your store locations.

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Use barcode scanners 

Consider equipping your staff with barcode scanners to speed up counting inventory. While manual counts are possible, using a barcode scanner in combination with the Stocky app makes counting inventory much quicker and simpler.

Once you scan an item, inventory levels for that SKU are recorded in a digital stocktake form and you can reconcile any shrinkage directly from your POS system. 

Organize inventory before counting

Keep your physical inventory impeccably organized and consider doing a store-wide cleaning— including your sales floor and stockroom—before you start counting inventory.

Label boxes and shelves in your stockroom or warehouse, clean up each section of your sales floor, and make sure items are in the right place and easy for counters to find. 

Regularly count inventory 

Counting and reconciling inventory shouldn’t be something you do once a year. The more often you count and reconcile inventory, the more likely you are to have accurate records. Consider cycle counting in between your larger stocktakes to monitor and address shrinkage. 

Compare your shrinkage rates after each count

Your shrinkage rate represents a sunk cost. Naturally, you want to make that number as low as possible. 

After each count, it’s important to find your shrinkage rate and to measure against past counts. Is your shrinkage rate growing? Perhaps look into more closely monitoring your inventory and being vigilant for theft. Is your shrinkage rate shrinking? Awesome! That’s more money to cover fixed or variable expenses. 

Keep track of your shrinkage rate over time and make it one of your key performance metrics. While most retail stores experience some degree of shrinkage, aim to keep shrinkage rates below 1%.

Get started with inventory reconciliation at your retail store

Routinely counting and reconciling your inventory ultimately assures you have an accurate record of inventory on-hand. The result is more accurate reporting, which makes for more cost-effective restocking.

In short, it helps you do more with the money you invest into inventory and assures that—if you’re losing revenue to shrinkage—you’re aware of the problem and can find a solution.

Inventory reconciliation FAQ

How are inventories reconciled?

Compare your inventory records with the physical inventory available to reconcile inventory. The objective is to make sure there are no discrepancies between the two values.

How do you reconcile ending inventory balance?

Ending inventory is the sellable stock available at the end of an accounting period. To find your ending inventory balance add net purchases to your beginning inventory and subtract the cost of goods sold (COGS). 

Ending inventory balance = (beginning inventory + net purchases) - COGS

In order to reconcile your ending inventory balance, count the physical ending inventory for the same accounting period to make sure it matches your calculations. Then update discrepancies in your POS system.

How do you reconcile stock in Excel?

Ending inventory is the sellable stock available at the end of an accounting period. To find your ending inventory balance add net purchases to your beginning inventory and subtract the cost of goods sold (COGS). 

Use an excel spreadsheet to keep track of your physical inventory counts and the amounts on record. This way, you can easily compare the two to understand discrepancies and the inventory quantities you actually have on hand. Add the following columns to your spreadsheet: 

  • SKU number
  • Last reconciliation date
  • Location
  • Record count (what you have in your system) 
  • Physical count
  • Difference between physical count and inventory record
  • Reconciled (checkbox)

What are the types of inventory reconciliation?

There are three main inventory reconciliation types: 

  • ABC method. Inventory reconciliation is organized by the percentage of your total revenue the products represent. 
  • Seasonal method. Inventory counts and reconciliation conducted based on seasonal demand. 
  • Arbitrary method. Counting and reconciling inventory based on how it’s categorized in your POS system or organized in your store.