What Is a Physical Inventory Count?

A physical inventory count is a structured approach to counting a company’s stock where staff uses a
predetermined method to count the goods. Companies schedule a physical inventory count at the
end of a reporting period.

The Four Types of Physical Inventory Counts

There are four types of inventory counts: manual, electronic, cycle counting and full
inventory counting. The methods vary but choosing the right technique can be the
difference between good and bad data for your company.

Pros and Cons of the Types of Inventory Counts

Physical
Inventory Description Pros Cons
Method
This count uses paper
count cards or sheets and
Manual Completion Low cost for materials High rate of errors
pencils to record
inventory.

This count can use This method still takes

Cuts down significantly on
Electronic Counting scanners, RFID, barcodes extra time and resources to
counting errors.
or mobile devices. complete.

It cuts down on extra time Depending on the cycle

Staff count random
or resources necessary to counting method, some
portions or rotating
Cycle Counting count, and companies may companies count inventory
sections of the inventory
not need to stop less than the ideal number
at any given time.
operations during counts. of times.
Companies repurpose This method provides This method may require
staff or bring in temp accurate inventory records an operational shutdown
Full Inventory
staff to count all the stock for creating the annual and is labor- and time-
at one time. financial document. intensive.

Physical Inventory vs. Cycle Counting

A physical inventory is a comprehensive, often annual count of the stock a company has on-
hand. Cycle counting is a more systematic method of counting portions of the stock.
Companies sometimes conduct cycle counting as often as daily, and it’s advisable to
perform them at least quarterly.
Physical inventory is not always automated. Cycle counting is typically automated, however.
Automation streamlines the inventory process overall, whether physical or cycle counts. It
saves time, eliminates most human error, and enables real-time and useful data. The most
accurate inventory counts are those that combine cycle counts with automation.

Annual Physical Inventory Count

Businesses usually perform their annual physical inventory count before compiling their
annual financial reports. Performing inventory only once a year does not always yield the
most accurate results. The best inventory count practice depends on your business type and
goals.

The types of businesses that perform annual physical inventories include retailers,
manufacturers, wholesale distributors and e-commerce-based companies. They can do a full
inventory once or do cycle counting. In cycle counting, staff counts sections of stock on a
rotating or systematic basis. Read our cycle counting inventory guide to learn more about
this practice.

Even if you have an automated system that manages your inventory, experts agree that you
need to perform at least some physical inventory. A computerized system cannot replace a
physical inventory count. Businesses with small amounts of stock may still want to perform
annual physical inventories.

Companies with large amounts of stock, such as distributors, find freezing stock to count
inventory quite disruptive. Therefore, they may prefer implementing a perpetual inventory
system to appease their auditors and reconcile their stock numbers, instead of a full annual
count.

Benefits of Doing a Physical Inventory Count

Physical inventory counts are an essential part of keeping inventory records accurate and
current. Up to date inventory records provide for better forecasts of sales and purchases
and ensures you always have the right amount of product on hand.

Performing physical inventory benefits your customers, and accurate physical inventory
counts are a necessity. No end-user, be it consumer, reseller or wholesaler, wants to deal
with uncertain stock levels in this modern day of instant gratification. Customer satisfaction
is paramount. Updated inventory levels ensure that you can fulfil your orders for your
customers promptly or tell them when they can be fulfilled.

Another benefit of physically counting your inventory is to ensure you understand and can
plan for loss. Loss can come from theft or breakage. Every day that an item remains in
inventory, its value decreases. As the value lessens, the risks of the cost to stock the item
outweighing its value becomes very real.

Performing physical inventories improves your profits overall. You can classify certain
products in your warehouse as obsolete inventory, which is a valuable method for
identifying which items to market and merchandise for quick sale. This process also reduces
the liability and break even, at least, for questionable products.

Issues With Physical Inventory Count

The biggest problem companies cite with conducting physical inventories is that they take
up a lot of time and resources. Some companies shut down parts or all operations to
perform their physical inventory. When this happens, they risk poor customer service.

Some businesses do not have the staff to complete a full physical inventory.

Usually, discrepancies happen in a physical count because internal or temporary staff don’t
accurately record some of the inventory, or they classify items or record new items
incorrectly. Regardless of accuracy levels, there are some things staff should not be counting
during the physical inventory. These include:

• Supplier receipts after the count’s decided-upon cut-off date

• Any known thefts
• Any known shipments that departed without invoices

Tips & Best Practices When Preparing for a Physical Count

The best way to perform a successful inventory count is through detailed planning. Using a
comprehensive written policy and instructions decrease unknowns and streamline a
physical inventory count.

Other tips to improve your staff’s counting accuracy include:

• Using scanners or other stock counting technology

• Selecting staff who are attentive counters
• Addressing discrepancies immediately
• Performing a mock count during the planning
• Ensuring the cost of the item counted is not displayed during the count
• Stopping operations when performing a complete physical inventory
• Ensuring that staff on-site during a full physical inventory are only there for the
count
• Securing the stock area on the day of the inventory
• Using inventory software

Purpose of a Physical Inventory Count

A physical inventory can ensure an accurate inventory tally. Staff physically count each piece
of stock. This physical inspection of goods should confirm what’s in the inventory
management system report. Any discrepancy should alert you there’s another issue.
Businesses perform physical inventories for other reasons, such as when preparing a
balance sheet for tax season. Additional objectives of an inventory count include:

• Check and Balance Inventory Levels: Physical inventories can help managers see any
discrepancies between their inventory management system reports and what items
are in their storage.
• Manage or Monitor Theft: The difference between what appears in the inventory
management system, and what is present can be due to missing, stolen, lost or
broken items. Unless staff manually enter when these scenarios occur, the system
would not recognize them.
• Create an Accurate Budget: Companies with precise inventory counts can better
plan their budget for the next year’s inventory orders.
• Report Accurate Earnings: An inaccurate inventory means a company will report an
incorrect amount for the cost of goods sold, the gross profit and net income. Public
companies are primarily accountable to their stakeholders to provide correct figures
in their annual reporting.

The types of inventory stock that companies need to count physically include raw materials,
works-in-process (WIP), finished goods, packing materials and maintenance, repair and
operations (MRO). Using the right inventory metrics can help you measure the relative
success of how your company stocks and manages these inventory categories. You can use
inventory turnover as a metric of success for all of these categories. However, there are
additional metrics that are good practice for each type of inventory. The chart below shows
examples of which metrics are good practice, based on each category.

Step-by-Step Physical Inventory Count Instructions

Performing successful physical inventories requires appropriate planning, preparation and
staff guidance. Involve managers in every step and have them provide advice and oversight
to get the best results. Start planning your physical inventory at least three months in
advance.

When providing counting instructions, you could use a written company policy that you
always follow or prepare a new plan each year. Make sure you cover the following activities
before any scheduled inventory count:

1. Start with a Plan: If your company has one already, great. If you are making the plan,
start by figuring out if your company is already controlling inventory with a periodic
or perpetual inventory system. Read our “Essential Guide to Inventory Control” to
learn the most efficient method to count your inventory based on where SKUs are
located in your warehouse.
2. Decide on the Interval Between Counts: As part of the plan, decide how often you
will count inventory. An accurate record of inventory is required for tax purposes in
publicly traded companies, but you can choose to count stock more often.
3. Draft the List of Inventory Items to Count: This draft list should include stock
quantities. Knowing this number should help you determine how long a physical
inventory count will take.
4. Select an Inventory Date: Ideally, this date you pick to do inventory has a minimal
effect on your regular business operations, as physical inventory counts are time
consuming. Choosing a time that won’t cause some workplace disruption isn’t
always possible with bigger businesses or supplier-warehouses but try to pick a time
that’s not particularly busy.
5. Choose Who Will Take Inventory: Once you settle on an inventory date, figure out
what staff can do the counting. One good practice is to perform a cost analysis of
staff salaries and overtime to determine how much it costs to perform a count. It
may be more economical to hire and train outside temporary help in large
businesses. Outside supplemental staff can free up some of your regular staff to
continue necessary operations.
6. Select Staff Training Dates: In the same way you choose your inventory date, you
need to choose one (or two, in the case of larger staff) dates to train staff on the
inventory counting process. This training should occur no more than one week
before the scheduled count, preferably the workday(s) right before the count.
7. Notify Outside Partners and Storage Locations: Suppliers and partners should know
well in advance if your physical count will affect their operations, so send a message
with the date, time and how the count will affect them. Earlier communication
allows your partners to contact you with questions and concerns.
8. Notify Staff: Begin the process by notifying staff of the training and counting
schedule. Decide, based on seniority or already-existing delineations, who will be on
each counting team. Some companies prefer to pair an experienced staff member
with a newer one.
9. Order the Necessary Equipment: Whether your staff will use clipboards and pencils,
count tags, or scanners, order them in enough time to arrive for training. Count tags
are heavy cards with sequential numbering stamped on the top and bottom that
counters use to track inventory.
10. Check Your Electronic Equipment: If you’re using electronic counting equipment,
plan to check it well before the count. You may need to order parts, change batteries
or charge devices.
11. Review Any Apps and Software: Don’t forget about software updates! If you are
planning to use apps or inventory software, verify that your staff is using the most
current version.
12. Preview the Inventory: Take a walk around the stock room or warehouse. You may
get ideas about how to decrease any challenges the counters may face. For example,
there may be temporary physical barriers that can slow them down.
13. Prepare the Space for the Inventory Count: Designate any additional areas needed
for counting or staff. For example, if you will pull out small parts to count in this
area, set up bins to use during the count. The inventory area should be free from any
clutter or trash.
14. Do an Inventory Clean-Up: Storage areas should always be the neatest area in any
warehouse. However, there should not be any products waiting to be put away or
out of their normal storage area.
15. Identify Stock That’s Not in the Count: Use signs to show stock that’s not in the
count. It is easy for staff to become confused during a long session and start
counting these items without clear markings.
 16. Prepare Your Final Item Count List: Create a final version—including quantities—of
your initial inventory list that staff will count.
17. Train Staff on the Procedure: Staff will need written instructions on how to perform
the count. Consider any contingencies that may happen, such as duplications,
missing items and those in the wrong place. Decide how to handle these scenarios in
advance. For example, staff may encounter the wrong product in a location. Decide
whether they should stop their count and report back in, fill out a new card for the
item present and count it or investigate the discrepancy.
18. Train Staff on the Equipment: During this same training, if you’re using count cards,
teach staff how to complete them. If you’re using electronic equipment like
scanners, train the team on how to use all the functions necessary and troubleshoot
any equipment issues. Include directions about what they should do if the
equipment malfunctions.
19. Perform a Demonstration: During the training, a demonstration of how to count the
stock is helpful for staff.
20. Stop Entering Data Before the Count: Before printing the line item list for counting,
be sure to freeze any data entry in the inventory management system to decrease
discrepancies. `
21. Pre-Count the Inventory: If possible, pre-count some pieces of the stock as a sort-of
dry run. Look for counting issues and annotate if the pre-count area needs
recounting or if you consider it complete.
22. Print the Count List: If you are using pencil and paper, print the final list the evening
before or the morning of the count to ensure you capture any last-minute details.
23. Freeze Other Activities: In the case of a full count, freeze any other company
activities related to inventory. In other words, do not receive or adjust any stock in
the company until the count is completed and reconciled

The Physical Inventory Counting Process

After producing a detailed, appropriate inventory counting plan, it’s time to execute the
physical inventory process. Assign a supervisor to each team of counters to whom they
report and all the equipment they need.

The process on the day of the count begins with the managers freezing the inventory items.
They should also have printouts of the list of inventory that will get counted. The next steps
in a physical inventory count are:

1. Assign maps, inventory to-be-counted printouts, and equipment to staff.

2. Staff counts the assigned inventory.
3. Staff fills out spreadsheets or count tags.
4. Staff returns the spreadsheets or count tags to the managers. If the staff is using count tags,
they affix the top portion of the tag to the stock or stock holding area.
5. Managers enter the data into the inventory system.
6. Managers compare counting data to data in the system.
7. Managers compare data against yield & pack reports.
8. Managers assign staff to investigate any discrepancies.
9. Staff recount or justify the discrepancies.
10. Staff resubmits any data changes to managers.
11. Once managers validate the count data, they send it to the accounting department.
12. Accounting audits the inventory count data.
13. Accounting approves the inventory count.
14. Managers unfreeze the stock and return to normal operations.