Physical inventory definition
/What is Physical Inventory?
Physical inventory is an actual count of the goods in stock. This can involve counting, weighing, and otherwise measuring items, as well as asking third parties for counts of inventory items that have been consigned to them. If a business is maintaining inventory records for each item in stock, then these counts are compared to the recorded balances; the recorded amounts are then changed to match the physical counts.
Physical Inventory for a Periodic Inventory System
If a business is maintaining a periodic inventory system, a physical inventory is used to derive the ending inventory balance. This information is then used to calculate the cost of goods sold since the last physical count, using the following formula:
Beginning inventory + Purchases - Ending inventory = Cost of goods sold
In a periodic inventory system, the inventory valuation is only correct on the day when a physical inventory is taken. From that point on, there is a divergence between the value of the on-hand inventory and the value of the inventory as of the day of the physical count.
Physical Inventory for a Perpetual Inventory System
In a perpetual inventory system, there is no immediate need for a physical inventory. Under this system, additions to inventory are added to the inventory records as they occur, while removals from inventory are deducted from the accounting records as they occur. Theoretically, this should mean that there is never a need for a physical inventory. In reality, theft and spoilage will result in an on-hand inventory that is lower than the amount indicated in the inventory records. Therefore, to improve the accuracy of the inventory records, it is customary for an organization using a perpetual inventory system to still conduct a physical inventory count - usually at the end of its fiscal year, and sometimes more frequently.
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Advantages of a Physical Count
Though it is time-consuming, a physical count offers several advantages that contribute to better inventory management and business operations. These advantages are as follows:
Accurate inventory records. A physical count ensures that the inventory records match the actual stock on hand, reducing discrepancies due to errors, theft, or damage.
Identifies losses. A physical count detects theft, pilferage, or unrecorded shrinkage. It also helps to spot damaged, expired, or obsolete goods that might not have been properly accounted for.
Improved inventory control. A physical count encourages better inventory management by providing a clear snapshot of current stock levels. This enables businesses to optimize reordering and prevent overstocking or understocking.
Improved forecasting. The more accurate records resulting from a physical count serve as a baseline for future inventory projections and demand forecasting.
Improves accountability. Physical counts encourage accountability among employees when inventory is regularly checked.
Opportunity for stock reorganization. Physical counts often involve organizing inventory, cleaning storage spaces, and improving stock placement, leading to more efficient operations.
Identifies errors. Physical counts can highlight issues with inventory management systems or processes, such as software bugs, data entry mistakes, or scanning errors.
While a physical inventory can be resource-intensive, conducting it periodically helps businesses maintain accuracy, minimize losses, and ensure smooth operations.