Counting on Cycle Counts? A Re-Think May Be in Order

Mark Boheim, Associate Director Internal Audit and Financial Advisory
Andy Flach, Associate Director Industrial Products Sector Lead

As anyone involved with inventory knows, cycle counts are a great way to stay on top of inventory throughout the year without the disruption and extensive cost of the annual physical count. By simply counting different classes of inventory at an agreed-upon rate – 2 or 3 times a year depending on cost and turnover rates – organizations are able to validate their inventory’s existence throughout the year and avoid a full physical count. The success of cycle counts, of course, depends on a number of conditions, such as count accuracy over time being above industry standards, a relatively consistent marketplace and rigorous adherence to processes and operations.

With the onset of COVID-19 and the underlying impacts, the underpinnings of cycle count programs have been severely affected. Demand for goods has shifted dramatically, and changes in suppliers and new regulations have created unprecedented obstacles. Requirements for physical distancing and lower resourcing levels have strained companies’ capacity to perform routine tasks. Furthering the challenge, many companies have switched to producing completely new products to meet new marketplace demands. Automotive manufacturers in the U.S. have shifted portions of production to support new demands for medical equipment. Clothing manufacturers have shifted production tooling to accommodate the rising need for face coverings.

Despite the massive changes brought about by the pandemic, cycle count programs can still be an economical and efficient way of staying current on available stock, for both financial reporting and operational fulfillment purposes. But to ensure the reliability of cycle counts and stave off the necessity for a full wall-to-wall inventory count at year-end, organizations need to revisit the design and approach of their programs, given the impacts of COVID-19.

Sustaining the Cycle Count

While re-evaluating the company’s cycle count program during a global pandemic might seem like a lot of work, companies should consider the flip side: It is an opportunity for leadership to take a fresh look at inventory management and to further strengthen their processes. The first step in the evaluation of a cycle count program is to perform an assessment of the company’s inventory, including changes in the company’s inventory turnover and/or product mix. These changes could affect a product’s inventory classification (“ABC” structure) and associated count frequency. For example, a previously low-demand product (let’s say, C-rated hand sanitizer) may now be classified as high demand and moved to a higher counting frequency (A category).

Building off the initial assessment of changes to inventory and product mix, organizations should consider the reliability of their cycle count program YTD, including results of counts both before and after COVID-19 changes, while layering in go-forward expectations. Here, companies should look to understand the results of the count program prior to and during the transition to the current COVID-directed “new normal,” including adherence to frequency and accuracy metrics. This second step in evaluating the reliability of the cycle count program provides companies with a comprehensive view of the current state and what needs to be accomplished over the rest of year to meet the needs of the various stakeholders in the cycle count program. While the regular cycle count rhythm may have been temporarily disrupted during the early days/weeks of the pandemic, robust execution and results of cycle counts pre- and post-disruption should enable organizations to avoid a full physical count at year-end.

With this holistic understanding of where the company is in the program and the future outlook, organizations can evaluate which items may need to be counted more frequently prior to year-end in order to catch up with shortfalls in counts performed to date. As an added benefit, a comprehensive evaluation should indicate which items may not have to be included as frequently in the program going forward.  

As with any organizational or procedural change, inventory and finance management should engage the help of all stakeholders early and often. Auditors, both internal and external, as well as accounting and operational staff, can help determine the feasibility of current cycle count programs, especially the implications of “no-count” periods.

Finally, organizations must continue to demonstrate a high degree of accuracy to support the validity and effectiveness of their cycle count programs. Rigorous operational controls and procedures are key. With meticulous documentation, inventory managers should look to verify that their counts are above applicable industry standards for count reliability, generally requiring around 95% or greater accuracy.

As noted in a previous blog, the pandemic is putting traditional inventory processes to the test and forcing companies to adapt to this highly unusual situation by becoming more disciplined, creative and proactive – for example, by using technology to perform remote counting and verification. The silver lining is that some of these adaptations can result in ultimately more efficient, less labor-intensive practices that are also reliably compliant and meet the needs of organizational stakeholders.

Farrah Malik, Senior Manager with Protiviti’s Internal Audit and Financial Advisory practice, contributed to this content.

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