In order to receive all of the benefits from a good inventory management system, stock balances must be at least 97% accurate, every day of the year. This means that the actual available quantity of every item in the warehouse is no more than 3% greater or less than the available quantity displayed on your computer inquiry screens. If the computer says there are 100 pieces of an item on the shelf, there should be no less than 97, nor more than 103. Note that this standard works for most companies. Your company’s actual tolerance for error may be higher or lower.
Many companies are in the midst of conducting their annual physical inventory; every item is counted and, if necessary, the balance in the computer is adjusted to reflect the actual quantity on the shelf. Even if you assume that the physical inventory results in an accurate count of each stocked product (a big assumption for many firms), how long do the counts remain accurate? One month? Two months? Six months?
Our research shows that the more often a product is received or shipped, the less accurate is the computer stock balance. This makes sense. Every time someone goes to the bin is an opportunity for a mistake (or, to coin a new term, an “unequality event”) to occur. For example, material can be put away in the wrong bin, or the wrong product can be taken to fill an order. So, why not focus counting efforts on those items with the highest risk of error?
To change counting strategy to focus on these items, we must:
- Identify them by ranking by cost of goods sold (COGS) or hits.
A rank-based method directs you to count the items with a large number of dollars flowing through inventory (i.e., with the highest annual cost of goods sold) or to count the products with the largest number of transactions (hits) more often than slower-moving products.Ranking theory is based on “Pareto’s Law” (named for the 19th-century Italian economist Vilfredo Pareto) which basically states that, in general, 80% of the results of any process is produced by 20% of the contributing factors. Applied to inventory, this means that approximately 20% of your inventory items are responsible for 80% of your stock sales. In fact, we have often found that only 10%-13% of inventory items usually will account for 80% of sales, and that no more than 50% of stocked products will account for 95% of sales.If your computer system doesn’t have the capability to rank products, don’t worry. Ranking can be performed utilizing Excel or another spreadsheet software package. For a guide to utilizing spreadsheets to rank your products, please send an email to us at [email protected].
- After ranking your items, develop a cycle counting schedule. We suggest:
- “A” rank items (responsible for the top 80% of activity) are counted six times per year.
- “B” rank items (responsible for the next 15% of activity) are counted two times per year.
- All other products are counted once per year.
Frequently counting your “A” items will allow you to uncover the reasons for inventory discrepancies. As you correct your policies and procedures, your computer on-hand quantities will consistently be more accurate. When you have confidence in the accuracy of your inventory, reduce the frequency of your cycle counts. You may be able to assume that your slowest-moving products have accurate counts and skip counting these products! An occasional audit of the quantity of selected fast-moving products will ensure that quantities in your computer will continue to agree with what is on the shelf.