Over the years, one of the most misunderstood and misused processes I have found in inventory management is Inventory Cycle Counting.

Most of the time, people think that instead of having a yearly total physical count, you just break it down into smaller periodic counts. They do the counting and report the differences to Finance. They refer to it as a cycle count.

Unfortunately, I have to tell you, that this is a misconception. Inventory Cycle Counting is a methodology that allows you to eliminate the errors in your warehousing processes by implementing a continuous verification process, generating consistent Inventory Accuracy levels above 95%, and finally eliminating the need to have a total physical count. It should be considered a daily warehouse process, as it is to receive or dispatch orders.

Let’s start with the basics. How do you measure Inventory Accuracy?

Another definition that is usually incorrect in many companies is the way to measure Inventory Accuracy.

Let’s say you are counting your inventory. First of all, the count needs to be a “blind count”, this is so because the person counting must not know or have access to the inventory quantities. You just give them a blank page with the item IDs, descriptions, and locations (if you have a controlled warehouse) that they need to count. They should bring back the number after the count and a third party should do the comparison with the numbers in the system and establish differences. If there are variances, the first step is to do a recount, usually with another person to eliminate the human error component.

Next is to identify if there are “significant” variances in inventory, for this, you need to introduce a concept called Counting Tolerance. This concept is directly related to the kind of counting and inventory handling processes you have for this specific item.  Let me give you a couple of examples, so you can better understand this concept: if you count something by the unit or by the box, you do not have any uncertainties regarding the count, so your Tolerance = 0. Thus, if you count 100 boxes of cereal, then you must have 100 boxes in your inventory. However, if the counting process is not that precise, let’s say you are counting small bottle caps, most probably you will use a counting scale to determine their number. A counting scale result would have a related uncertainty since there is a natural variation in the weight of each cap and it calculates a number of units in terms of their net weight. Therefore, this uncertainty is your counting tolerance (1-2%). Finally, you could have certain items, usually, powder or liquid raw materials, where there is natural evaporation or handling loss of the product, this item handling-related variation is also your inventory tolerance. Remember, if your count is within the defined tolerance, you would conclude that it does not have a “significant” variance, and it is correct.

To define tolerances, you need to understand each item and its handling and counting limitations. Then agree on this tolerance with your Finance Department.

Let´s do the calculations: You will receive the results from the blind count and you need to compare the numbers against the numbers in the system:

Some people would tend to calculate an “accuracy” for each item and then obtain an average accuracy for their inventory numbers. Something like this: (99.0% + 99.95% + 98.6%) / 3 = 99.2%. But this is not correct, and it is misleading, reflecting a very high inventory accuracy level when there is not.

In this example, the correct inventory accuracy (IA) for the day is 2/3, 67%. Usually, the global KPI would be calculated by reflecting the total counts of the month and the total correct counts in that period, using the same formula. Let’s say you counted 200 SKUs in the month, and 185 were correct, then your monthly IA = 185/200 = 92.5%.

Sometimes this concept is difficult to understand, and people consider it too acid, but when you get the idea that what you are measuring is not the “number of units” but the accuracy of your warehousing processes, then you will accept that for this example, from three results, only two are valid and one reflects a problem in your processes, so your inventory accuracy for this sample is just 67%.

This needs to get even more acid when you work in a controlled warehouse (a warehouse where you keep track of inventory locations and/or lot numbers). The count and comparison need to be done by location and by lot number. If you have one unit in the wrong location, even if the total count is correct, you will have two wrong counts by location. On the same hand, if you have the exact inventory quantity but the wrong lot number, then you will have a wrong count, even having the exact number of units or Kg, etc.

Now we are ready for Cycle Counting

Once you understand how Inventory Accuracy should be calculated, you will start to understand how to improve that indicator. In my experience, companies that start working with cycle counting will begin with inventory accuracies of around 60%, so do not worry this is normal.

How should we start? Well, most people would simply try to define what they want to count every day and do it. That is wrong again. You first need to implement a method to quickly improve your accuracy levels. This method is called: Control Groups.

Control Groups are groups of items, that you are going to count over and over again until they maintain very high accuracies. The final goal of these counts is to help you eliminate errors in warehousing processes as fast as possible and improve results for every item in the warehouse.

The counting process for Control Groups, and any other Cycle Count, is the following:

Like in any other count, you make a blind count, you establish the differences, and you recount to make sure there is no counting error. From there, you need to exactly pinpoint the transaction (or lack of it) that caused the difference in numbers. Correct the quantities accordingly, and at the same time define an action plan to correct the process and avoid the same error from happening again.

How do you select Control Groups? Select common items that have many transactions (not that many that make it impossible to trace them, and not too few that won’t allow any errors to happen). How many items should you select? Well, you will have one Control Group for every day of the week, and you need to make sure that you can complete all the steps of the process for all items in the group within a set amount of time: let´s say 30 min or one hour. Therefore, define as many items for each group as you can handle every day with the available resources in your team.

Now you should define a daily time for Cycle Counting, it can be first thing in the morning or at the end of the day. While doing CC, you need to stop all the operations, to avoid inventory movements. So, you need to coordinate this with customers, vendors, and managers.

You will count like this:

You will count the exact same items one week apart. Why? because when you reach the activity to identify the errors, it will be easier to compare documents and system transactions and to pinpoint the problems when you counted the item just 5 days before. If there are too many transactions to identify the error, then you could select some less dynamic items, or count the same group more frequently, for example, every 3 working days instead of 5.

Once you do your analysis, most probably you would find problems like this: somebody did not process a transaction, somebody duplicated a transaction, somebody entered a wrong number (maybe missed a decimal point), somebody processed the wrong item, etc.

Therefore, now that you identified the problem you can correct the inventory quantities, but most importantly, you should sit with the team and implement corrective actions to attack the root cause for that specific error (you could use six-sigma or other continuous improvement tools: it could be training, automating some processes, improving counting tools, getting bigger monitors, improving illumination, improving form design, etc.)

If you keep doing this every day, very soon (3-4 months) you would eliminate most of your process problems and watch your inventory accuracy skyrocket. As a rule of thumb, if you get 100% inventory accuracy for more than 3 straight weeks for a control group, then you should replace that group with a new one. Finally, if you reach 100% accuracy for all your control groups for more than 3 weeks, well then you are ready to go to Regular Cycle Counting.

Regular Cycle Counting Process

At this point, you have already achieved two main goals of cycle counting:

• You have eliminated most of the problems in your warehousing processes
• You have acquired a daily commitment to counting in your warehouse team

Consequently, starting a regular cycle counting process would be very easy to do. There is just a switch in the process goal: Now you need to count every item in the Warehouse at least one time in the year (slow-moving items) or many more (fast-moving items) to maintain a very high IA and completely eliminate the need for a total physical count.

How do you achieve this goal? You will need to do the following:

1. Start with a Total Physical Count (hopefully, the last one) so you have the correct inventory numbers for each item. At the same time, try to clean your warehouse of all inactive items, damaged items, etc. Try to purge all things you have been accumulating for years and start clean.
2. Most WMS / ERP systems will allow you to define the criteria for CC (usually by product group): Number of Transactions, ABC classification, Item Cost, planned number of counts per year, number of items per count, etc. Once you define these criteria the system will help you to define the daily Cycle Count List. The warehouse team needs to count these items the same way they did for the Control Groups, using the same steps in the process described before.

Since you have started CC with high inventory accuracy (physical count) and you have improved your processes (control groups) then you should now have, and be able to keep, Inventory Accuracy (IA) levels over 95% most of the time. If for some reason IA drops below 90%, you can introduce some Control Groups in the process again. They would help you identify and eliminate current errors in the process. Eliminate these groups when your IA is back to the desired level.

Final Recommendations

 I hope these ideas had helped clarify some of the misconceptions regarding Cycle Counting. I have implemented it many times, in different companies and industries, and I know that one of the main reasons for failure is business pressure on the warehouse team to stop the counts to receive or dispatch orders. There are always emergencies with higher priorities than counting. The best way to relieve this pressure is to have your senior management involved and sponsoring this process. Remember that without Inventory Accuracy any planning system or methodology would fail. Counting your inventory is as important as receiving vendor orders or delivering customer orders, it is not a second-class process.

Finally, when eliminating your yearly inventory physical counts, it is important that you interact and explain the rationale behind it to your Finance Area and your External Auditors. They need to understand and support this decision.

Juan Pablo Franco

General Manager