Discovering an issue with your store’s inventory is a headache. That’s why regular inventory audits are worthwhile—even if they’re not the most interesting part of running a retail business.
Audits keep stores operating efficiently and may be legally required. Here’s an overview of inventory management and counting procedures, plus a checklist to follow when performing your next audit.
Table of Contents
What is an inventory audit?
An inventory audit is the process of cross-checking your actual inventory levels against financial records. It makes sure that physical inventory matches what’s in an inventory system.
Audits may also look at how a retail business is counting inventory, identifying ways to become more accurate. Audits can be performed by store owners or external auditors.
Auditing your inventory reveals your true inventory levels (the stock you have on hand at your store or in your warehouse) and gives a snapshot of the health of your supply chain.
When you run regular inventory audits, you might spot specific SKU numbers with more frequent issues than others, and catch discrepancies before they can become a bigger problem.
💡 Tip: Shopify POS has tools to help you control and manage your inventory across multiple store locations, your online store, and your warehouse. Count inventory, forecast demand, set low stock alerts, know which items are selling or sitting on shelves, and more.
Importance of inventory audits
Now that you know what an inventory audit is, let’s look at why they’re important for your retail store.
Audits ensure inventory accuracy
The biggest benefit of regular audits is peace of mind. Your business decisions should be driven by data analysis, and every inventory audit adds real-time data for you to analyze.
Data from physical inventory counts can inform:
- Demand forecasting and product planning
- Scheduling for marketing campaigns and staffing
- Safety stock needed to prevent stockouts
- The ideal reorder point based on product demand
- Store layout and product display
Inventory audits identify shrinkage
Shrinkage is when a store has fewer inventory items than are listed in its records. Causes of inventory shrinkage include shoplifting, employee theft, administrative errors, vendor fraud, and product damage.
According to the National Retail Federation, shrinkage is a nearly $100 billion problem in the retail industry. When not quickly identified, it can create phantom inventory, or inventory your inventory management system falsely says is on hand.
Noticing shrinkage on time means you can correct records and order new inventory quickly, instead of being forced to display out-of-stock notices. It also gives you an opportunity to investigate and solve the causes of shrinkage.
Inventory audits are required for public companies
Public companies must perform audits if their inventory is material to a company’s financial statements. That means inventory is classified as a current asset on the company balance sheet.
Search for guidance from financial organizations and experts to understand auditing requirements in your location. In the US, for example, you can find up-to-date information on AICPA, the American Institute of Chartered Professional Accountants (CPA).
11 inventory audit procedures
- ABC analysis
- Cut-off analysis
- Physical inventory count
- Cycle count
- Analytical procedures
- Overhead analysis
- Freight cost analysis
- Finished goods cost analysis
- Product reconciliation
- Match invoices to shipping log
- Inventory layers
When it’s time to do an inventory audit, you can combine different counting procedures to fit your company’s needs, industry, and audit frequency.
1. ABC analysis
ABC analysis is an inventory categorization method that groups items based on value:
- A = 20% of stock that represents 80% of your revenue
- B = 30% of stock that represents 15% of your revenue
- C = 50% of stock that represents 5% of your revenue
Products graded as A are high-value items for your store, while C marks low-value items. By knowing which products belong to which category, you can prioritize inventory auditing and organize your backroom or warehouse to facilitate them.
2. Cut-off analysis
Cut-off analysis involves pausing warehouse operations like shipping and receiving while you conduct a physical inventory count. This way, you can ensure all financial reporting is up to date, and no transactions or inventory changes slip through the cracks.
3. Physical inventory count
A physical inventory count involves manually counting the stock in your store, from the sales floor to the back room, and comparing the physical inventory levels to those recorded in your point-of-sale (POS) system or inventory management system. This also takes into account stock levels for different product variants, like colors and sizes.
A full physical count can disrupt day-to-day operations because it counts every item in the store. Still, it’s the most common inventory audit procedure.
4. Cycle count
Cycle count is the process of counting a small group of products at a specific time. It’s done regularly on a predefined number of products, and makes it easier to keep an accurate inventory of valuable products without disrupting business.
5. Analytical procedures
Analytical procedures involve financial and operational metrics like inventory turnover ratio, gross margins, unit cost of inventory from the previous years, and inventory days on hand (DOH).
6. Overhead analysis
Overhead analysis takes into account the indirect costs of running your retail business. This includes rent, utilities, insurance, and other costs, not including salaries and direct materials.
Knowing your overhead costs helps you budget and plan for your store accordingly.
7. Freight cost analysis
Freight cost analysis looks at freight shipping costs, the time it takes for a product to be shipped, and instances of products that are lost or damaged in transport.
This is how you can keep track of your shipping costs and the inventory lead time. Shipping costs are typically part of the value of inventory, so knowing them is essential.
8. Finished goods cost analysis
Finished goods cost analysis is relevant for retailers who manufacture their products. When a product is ready to be sold, its value can be included in inventory for the current financial period to ensure that accounting records are accurate.
9. Product reconciliation
Product reconciliation, or inventory reconciliation, involves making adjustments to discrepancies between your financial statements and the physical inventory you have on hand.
As you reconcile your records, keep track of products that are more likely to divert from the inventory levels in your system. This way, you can monitor them to avoid future issues.
10. Match invoices to shipping log
Matching invoices to shipping logs is about matching the cost and amount of inventory you received with financial records from your invoices. This can be done at random to spot-check inventory for a specific time period.
This procedure confirms that the correct amount was charged at the right time and for the correct inventory.
11. Inventory layers
Inventory layers are the quantities of items received or grouped together that share the same costs. If you’re using FIFO (first-in, first-out) or LIFO (last-in, first-out) inventory management principles, it’s worth looking at the inventory layers you received and making sure they’re correct.
Inventory audit checklist
- Create an inventory audit schedule
- Prepare your documents and data
- Assess and prepare your inventory
- Select audit procedures
- Choose who’s auditing
- Conduct the physical count
- Reconcile records that don’t match the physical count
- Record inventory audit results
- Compare findings with previous audits
- Identify potential causes of shrinkage
- Look for opportunities to improve inventory methods
When you’re gearing up to conduct an audit, use this checklist to prepare the materials you’ll need, execute the audit, and analyze its results.
The planning stage
1. Create an inventory audit schedule
What is a frequency that makes sense for your store’s size? Which periods are slow enough to minimize disruption to your operations?
2. Prepare your documents and data
This includes balance sheets, invoices, and data from your inventory management software.
3. Assess and prepare your inventory
Ensure all inventory is unpacked, pallets are accessible, and no items are at risk of being left out or counted twice.
The execution stage
4. Select audit procedures
Does your store need a full physical inventory count? Can you focus on high-value items from your ABC analysis or implement a cycle count? Do you want to include any other parameters, like freight or overhead analysis?
5. Choose who’s auditing
Are you conducting the audit internally or through an external service? Will there be an auditor present to observe and spot-check your process?
6. Conduct the physical count
No inventory should be moved in or out of your store or warehouse during this stage. Take note of your counts using a point-of-sale app with inventory capabilities, like Shopify POS, or use a tool like Excel.
7. Reconcile records that don’t match the physical count
This helps you start your next period fresh and keep track of items that tend to mismatch.
The analysis stage
8. Record inventory audit results
Take note of everything you count, but pay particular attention to products and categories that have discrepancies.
9. Compare findings with previous audits
Are there products more prone to mismatches or suppliers whose products are a frequent issue? Are some periods more of a problem than others (like a busy holiday season)? Products that often cause inventory issues may need more frequent auditing.
10. Identify potential causes of shrinkage
Look at what might be causing shrinkage so you can minimize losses. For example, product damage and vendor fraud might come from supply chain issues, and dead stock could mean you overestimated product demand.
11. Look for opportunities to improve inventory methods
Use your findings to explore ways to manage your inventory more efficiently and organize your warehouse better to minimize shrinkage and discrepancies.
Inventory audit challenges
Audits are time-consuming
Counting every item in your store and stockroom takes time and focused effort. Depending on your resources, you may even need to shut down operations, including closing your store and pausing inventory shipments.
Minimize the burden of audits by scheduling them for natural downtime and using systems that simplify the process. Helpful auditing tools include point-of-sale (POS) systems, bar codes, and radio-frequency identification (RFID) technology.
It’s hard to scale auditing as you grow
Inventory audits become a bigger burden as your store grows and your stock expands from a spare room into a warehouse.
Bigger physical spaces and locations to navigate, plus more SKUs to handle, mean you may no longer be able to perform a manual audit.
When that happens, switch to lighter, more frequent counting procedures, like cycle counts and ABC analysis—or integrate an inventory control system like perpetual inventory.
Audit your inventory with confidence
Inventory audits don’t need to be a draining, overwhelming experience. They’re a useful tool to prevent shrinkage and stockouts, and leave you confident about your store’s capabilities.
Follow these tips and checklist items to prepare your store for a successful physical inventory count. And don’t forget about tools like Shopify POS that automate product tracking for easier inventory management.
Inventory audit FAQ
What is the meaning of an inventory audit?
An inventory audit reviews a company’s inventory and records to check for accuracy and compliance. Inventory and records are cross-referenced to verify the physical count of stock. An audit may also include reviewing a company’s systems, processes, and procedures related to inventory management. Additionally, it might involve an analysis of the company’s inventory policies and procedures.
How do you run an inventory audit?
- Start by gathering all relevant inventory records, including purchase orders, invoices, receipts, and other documentation related to the inventory.
- Physically count inventory and document the results.
- Compare inventory records with physical inventory.
- Examine inventory levels to ensure they are sufficient to meet customer demand.
- If discrepancies exist between the actual inventory and records, investigate the causes and reconcile the differences.
- Document and report the results of the audit to management or external stakeholders.
What happens if you fail an inventory audit?
If you fail an inventory audit, you may face penalties. Depending on the reason for the audit and the applicable laws in your location, you might encounter fines or jail time. Ensure compliance with relevant laws, regulations, and procedures to avoid potential penalties.