What is Physical Inventory? How to and Tips (2024)

Ever notice that your stock levels don’t match your records? 

If an issue like that compounds over time, you’re destined for a future of financial loss and headaches. 

Fortunately, you have physical inventory counts—a process that brings clarity and confidence to inventory management, guaranteeing every item is accounted for. 

Ahead, you’ll learn the benefits of tracking physical inventory, as well as how to do an accurate physical inventory count for your retail store.

What is physical inventory?

Physical inventory is the process of counting and verifying the actual stock of goods in a store or warehouse. This manual count ensures inventory records are accurate, helps identify discrepancies, and assists in effective inventory management and financial reporting.

What is a physical inventory count? 

A physical inventory count is where retail staff count the store’s physical inventory and compare those levels to the inventory levels recorded in the point-of-sale (POS) system. It guarantees accurate inventory records, identifies discrepancies, and reduces the chances of stockouts or overstocks. 

Purpose of a physical inventory count

A physical inventory count, then, is the process of manually counting the stock you carry in store—from the sales floor to the back store room—comparing the inventory levels you count with the inventory levels recorded in your POS system and then reconciling any discrepancies. 

Typically, inventory counts will take into account the amount of stock you have for each variant of the product as well. 

Physical inventory counts can also include: 

• Raw materials
• Works-in-process (WIP)
• Finished goods
• Packing materials 
• Maintenance, repair, and operations (MRO) supplies

The goal of a physical inventory count is to audit in-store inventory levels and ensure that the inventory numbers recorded in your POS system are as close to 100% accurate as possible. The measure of your inventory levels’ accuracy is your shrinkage rate, which is the percentage of inventory missing from your POS records. 

For example, let’s say you counted 150 t-shirts in-store, but your POS system only has 145 on record. This means your t-shirt inventory levels are 96% accurate and that your shrinkage rate is 4%. 

In instances like this where you uncover a discrepancy between recorded and in-store inventory levels, it’s important to reconcile inventory (that is, adjust the inventory levels recorded in your POS to reflect what you have in store) to maintain accurately recorded inventory levels. 

When to do a physical inventory count

It’s a good idea to do a small physical inventory count when replenishing stock. Confirm that the total number of items (both new and existing) is accurate to give a starting point against which to compare future inventory checks. 

From there, the frequency of a physical inventory count depends on a number of factors, including:

• How many SKUs are in your inventory
• How many items are sold each day
• Which physical inventory method you’re using
• Whether you use inventory technology such as a POS system or bar code scanners

Let’s say you’re a small clothing boutique with 120 SKUs. There aren’t many items to count, and it likely wouldn’t take up too much of your time. So, a complete physical inventory count every month would be reasonable. 

A large retailer selling thousands of items each day, however, though they might need to increase the frequency of their physical stock checks, could limit each count to a smaller subset of inventory (known as a cycle count or partial inventory count) to make the process faster. 

Along with partial inventory counts, it’s recommended that merchants do a full physical inventory count at least once near the end of each calendar year. This assures you have an accurate inventory record when preparing your balance sheet for tax season.

Types of physical inventory counts

Manual counting

A manual inventory count is just that. Store associates will manually count each piece of stock both in the stockroom and on the sales floor and record the figures using pen and paper. Most stores avoid this technique, because it’s both time-consuming and prone to human error. 

• Advantage: Lower cost.
• Disadvantage: Prone to human error.

Electronic counting

With an electronic physical inventory count, store associates use both a bar code scanner and POS system to count stock faster and more accurately than is possible with manual counting. As a store associate scans each item, the inventory level for that SKU is recorded electronically. 

Not only does this drastically reduce the risk of over (or under) counting, it also provides a digital record of each inventory count, which can then be compared to inventory levels listed in the POS system for faster reconciliation.

• Advantages: Lowers risk of over- or under-counting.
• Disadvantages: Still time-consuming and requires staff to complete.

Cycle counting

Cycle counts (also referred to as partial inventory counts) are an inventory management technique where retailers only count inventory for a particular category of products rather than doing a full stock check. 

This technique is ideal for merchants who want to maintain an accurate record of their inventory while reducing the time it takes by breaking a big task into several smaller tasks. Unlike full inventory counts, which can require retail teams to close the store or work overnight to complete, cycle counts can typically be done during the workday. 

• Advantages: Can be done during the workday and is less time intensive.
• Disadvantage: Not scalable for growing businesses.

Full inventory counting

A full inventory count usually happens at the end of the calendar year, following the holiday rush, when inventory levels are typically at their lowest. Retail teams count all of the inventory in their store and start the new year off with an accurate record that includes the total cost of goods sold and retail value of their merchandise. 

Depending on the amount of SKUs your store carries, physical inventory counts can be a time-consuming undertaking. Typically, merchants will close their store to do full inventory counts or schedule a team to work overnight. As a result, many small retailers limit full inventory counts to once or twice per year, opting for periodic cycle counting in between. 

• Advantage: Provides accurate inventory numbers for balance sheets.
• Disadvantages: Often requires the store to shut down and is labor intensive.

What is the difference between physical and perpetual inventory counts?

Physical inventory is a stock-taking method in which retail staff manually count store inventory and adjust their inventory management system if they find discrepancies.

Perpetual inventory, on the other hand, happens when stock levels are updated after your point of sale system processes a transaction and the inventory levels for the items sold adjust automatically.

If you have five of a particular item in inventory and one gets sold at your checkout desk, for example, your POS system will automatically update the recorded inventory levels of that SKU to four. This automation streamlines the inventory management process and makes inventory control more efficient. 

Since stock levels are automatically adjusted when sales, returns, or exchanges are made, retailers can perform physical inventory counts less often than they would have had to if they had been using a spreadsheet or pen and paper to track inventory.

Benefits of having a physical inventory count process

Maintain inventory accuracy

Inaccurate inventory—whether of overall quantity or the stock levels for products of each size—causes a whole host of problems for retailers.

“Physical inventory count is a necessary step in inventory management because it reconciles the actual stocks in storage with the inventory count on the system,” says Stephen Light, CMO and co-owner of mattress brand Nolah. “If there’s a discrepancy, it means that there’s an issue. It could either be a loss of inventory or a failure to send out stocks to retail outlets.”

Improved demand forecasting

Demand forecasting is an important part of inventory management. It happens when you predict how much demand there will be for a product, how quickly it will sell out, and when that SKU will need to be replenished. 

Doing a physical inventory check also helps improve inventory forecasting and purchasing. With Shopify POS, for instance, merchants can view demand forecasting reports that recommend which products to restock based on their profitability and restock rate. This enables you to restock items based not only on their popularity but their profitability as well.

Prevent stockouts

“Sorry, this product is out of stock” is something your retail associates never want to say to a potential customer. 

According to a recent study, an out-of-stock product was the biggest reason for a customer’s decision to leave a store empty-handed. Those stockouts have a domino effect on retail sales.

Best Price Nutrition has 23 brick-and-mortar stores and a handful of Shopify ecommerce sites. With such a distributed inventory, its ecommerce manager, John Frigo, says, “people forget to do transfers, so inventory is always a challenge.”

“We do a physical inventory four times a year and do spot inventory checks on select brands and products included in stacks about once a month.”

Along with inventory counts, Shopify merchants can better control stockouts using reorder points and low stock reports. With low-stock reports, merchants can see products and variants whose inventory levels are approaching the preset reorder point and order more stock before running out.

Increase sell-through rate for struggling inventory

A physical inventory count doesn’t just prevent stockouts. Retailers also lower the risk of carrying unpopular inventory at full price for too long. With Shopify POS, merchants can access inventory grading reports that categorize products based on their cost per unit, selling price, number of units sold, and the total revenue generated over a period of time.

For products that aren’t selling as expected, merchants can consider re-merchandising them in-store: promoting them to drum up interest, or applying a special discount to incentivize purchases. This helps increase the sell-through of struggling inventory, to secure a return on your initial investment and make room for more popular items that either sell at a higher volume, higher margin, or both.

Reduce inventory shrinkage

Losing inventory, or stock shrinkage, is a common and frustrating problem for retailers. It happens when your actual stock is lower than the figure in your inventory management software. 

Employee theft and shoplifting are major causes of stock shrinkage, and should be watched for and prevented. 

A weekly partial inventory count, for example, can help retailers flag discrepancies between a store’s inventory on hand and the inventory levels recorded in its POS system of a smaller sample size of inventory that’s more manageable to count (one specific product category, for instance). Doing this weekly will give you enough time to identify what caused the shrinkage and reconcile it.

Perpetual inventory tracking, on the other hand, won’t highlight missing stock. Should employees steal stock or items be shoplifted, your inventory on hand will shrink, but will still show as available and accounted for in the POS system.

Avoid over- or understocking 

Failing to track physical inventory levels can result in carrying too much (or not enough) inventory, which has the potential to cause budgeting issues.

As of April 2023, the United States Census Bureau found that the average retail business had $1.39 worth of inventory for every $1 in sales.

The discrepancy between inventory on hand and demand for that inventory (otherwise known as overstocking) can lead to markdowns. While discounting has its uses, discounting at scale results in lost revenue as a result of lower-than-expected margins on each sale. 

With a good inventory management system and warehouse management system, you can keep an eye on inventory turnover more easily. By doing that, you can invest enough in inventory to meet demand without overstocking or understocking.

The physical inventory counting process

1. Plan, prepare, and assign SKUs

Counting inventory requires precision and planning:

1. Set a date for your stock check—be it in a week, month, or quarter’s time—and give the retail staff you schedule advance notice. 
2. If you plan to close your store during business hours, let shoppers know with an announcement on your social channels, a banner on your website, and signage in front of your store.
3. Train newer staff who haven’t done an inventory count before. Explain how to count items, the type of stock check you’re doing, and where they should record their results.
4. Draft a list of SKUs you’re taking stock of and divide it among your staff. For example, one person can take women’s t-shirts, another men’s shorts, and so forth. That way, each associate has a predetermined list to follow—and nothing gets double-counted. 

Finally, just before the stock check, tidy your stockroom and shop floor and give each team member enough space to count the product or category you’ve assigned them without getting in each other's way. 

2. Count your inventory

Whether you’ve decided to close your store for the day or schedule an overnight shift for the inventory count, what’s important is that customers not be in the store, buying or moving products around as they shop. 

During inventory counts, stock levels shouldn't be at risk of changing as a result of sales being made. Items need to be in their designated zones and ready to be counted. 

Have each employee get started on the SKUs for their individual stock check. Explain how to record the figures—either manually with a pen and paper, with a spreadsheet, or with a bar code scanner and mobile POS—and show staff how to add notes if an item is faulty, damaged, or missing a tag.

Finally, encourage each member of your staff to be on the lookout for products that aren’t in the appropriate place. Designate a bin for miscellaneous items, which the team can then filter through and see if any correspond with the SKUs they were assigned to count.

3. Analyze and review

The final stage of a physical inventory count is to analyze any discrepancies between counted inventory and the levels reported in your POS system, find your shrinkage rate, and approximate both the total value of the items that are unaccounted for and the total value of the items that were counted in-store. 

Next, try to find the source of any discrepancies. For example, your inventory count might say you have 100 units of a flower pot, yet reports show you ordered 95. Recount the physical stock, if needed, and do some investigating to figure out what might have caused the discrepancy.

Once your analysis is complete and you’ve recorded the results, reconcile inventory levels so that what’s in-store and what’s recorded in your POS system match.

Tips for taking physical inventory count

1. Leverage inventory management technology
2. Create a map of your store, stockroom, or warehouse
3. Label boxes and shelves
4. Clean up areas where count is taking place
5. Use bar code scanners
6. Schedule a convenient time for counting 
7. Train and inform staff
8. Create a list of included and excluded items

Leverage inventory management technology

Counting with pen and paper isn’t just time-consuming, it makes it easy to miscount and end up with inaccurate inventory information. Plus, a physical stock count over several store locations will churn out more data, which will take much longer to analyze and make sense of than if everything were recorded using software built for managing inventory.

Inventory management technology solves those problems. Using Shopify POS and a bar code scanner, for example, when merchants scan an item, inventory levels for that SKU will be automatically logged in the point-of-sale system. This makes for quicker inventory reconciliation and gives merchants a single source of truth for both inventory and their financials.

Apps like Stocky also notify you when stock is running low. Set reorder points for products so that once inventory levels approach that threshold you’re notified it’s time to reorder before inventory levels reach zero.

If you want to minimize the number of stock counts you do annually, using a POS system that supports perpetual inventory management can help. 

Shopify’s automated inventory adjustments, which occur whenever products are received, bought, returned, or exchanged online or in store, has helped brands like elph ceramics cut the time it spends on inventory management by 30 minutes each day.

Create a map of your store, stockroom, or warehouse

As part of your preparations, create a map of the areas where your inventory is stored—be that your shop floor, stockroom, or warehouse.

On the map, clearly label where each product category is located, and who you’ve assigned to count it. This will help the manager you’ve assigned keep tabs on who is responsible for what, and also help store associates orient themselves. 

Additionally, consider giving each employee a list of the SKUs they will count in their designated area; this can be a valuable point of reference, as they scan product bar codes and input their count into the POS system.

Label boxes and shelves

Alongside a map of your store, label boxes and shelves based on what products they carry—and make sure the items inside each are in the right place. 

These labels should reflect the store map you created in the step prior. Having a t-shirt in the shoe box, for example, causes confusion. The associate counting shoes will need to stop their count and place the t-shirt in the designated “Misc” bin. Similarly, the person counting t-shirts will have inaccurate information until the miscellaneous bin is sorted.

Treat the miscellaneous bin less as a catch-all and more as a last resort. Labeling boxes and shelves, and ensuring products are in their designated space prior to the inventory count, will keep everything on track and save time once the count is over and it’s time to account for the miscellaneous items.

Clean up areas where count is taking place

Ever heard the phrase, “a tidy environment is a tidy mind?” The same is true for inventory counting.

In each stock-taking area, make sure associates have enough room to count large quantities of product. Get rid of inventory items or boxes that don’t belong. Move any freestanding furniture—like mannequins or display cabinets—to the side.

Use bar code scanners

While manually counting items is an option, it makes teams more likely to miscount. Instead, opt for bar code scanners for faster and more accurate counts. 

Rather than manually counting and documenting each product in a spreadsheet or on paper, store associates scan the bar code on the product’s tag and the inventory levels associated with that product’s SKU are automatically recorded in the POS system. Unless a store associate scans the exact same item twice, chances for miscounts are minimal. For teams tasked with counting large quantities of inventory, bar code scanners are essential.

Schedule a convenient time for counting

The store needs to be closed when doing a physical inventory count. Any days you’re closed to the public—like Sundays—could be an opportunity to do a physical stock check. That way, you don’t have to turn away customers who turn up expecting to buy something.

Alternatively, some merchants opt for overnight inventory counts, scheduling a team of workers to come in when the store is closed. Just keep in mind that in many regions, overnight work requires compensating staff more than you would for a shift scheduled during regular business hours. 

It’s also worth putting a timeframe on your inventory count. It will take some stores a full day to do a physical count, while others need just a few hours—it all depends on how many products you carry. Either way, it’s better to give yourself too much time than not enough. 

Train and inform staff

Before starting a periodic inventory, take time to train your retail staff on how to do it. Everyone on your team should understand how to use a bar code scanner and your POS system to count inventory and log results. 

Also spend some time explaining common challenges they’ll run into. What happens if an item is missing a tag, is faulty, or is incorrectly labeled? Share the answer and the process you’ve implemented for each scenario so staff know what to do if they find themselves in that situation.

Create a list of included and excluded items

Depending on the type of inventory count you’re doing, not everything in your stockroom will need to be counted. 

Prepare in advance a list of which items do and don’t need to be counted. Give each team member a list of SKUs to count, and a list of those not to count. You’ll prevent people from double-counting or missing important items, and have high inventory accuracy. 

Excluded items might be: 

• Products that have been sold and are waiting to be collected by a customer
• SKUs already counted in a recent inventory cycle count
• Merchandise that isn’t for sale yet

To lower the chances of staff accidentally counting these items, it’s worth putting them in a separate location.

Keeping an accurate count of inventory at your store

The day you do a physical inventory count doesn’t have to be one your retail associates dread. By clearly organizing and labeling where products are located, having a physical inventory process in place, and using the right tools, stocktakes are more likely to go smoothly and errors due to miscounting or misplaced items should be kept to a minimum. 

Follow these tips to assure your next inventory count—whether it’s a cycle count or your annual physical inventory check—is well executed, helps you address inventory shrinkage, and keeps an accurate ledger of the quantity, cost, and retail value of the inventory you carry in store.