How can negative inventory happen?
Some people may ask whether negative inventory can exist, but the answer is yes, it can happen to any business. This may sound counterintuitive, as practically speaking, your inventory is a physical quantity of stock that you hold. However, certain events can cause the balance in your records to go into the red. These events can be roughly divided into the following two categories:
This is caused by a simple processing delay, usually when a customer makes an order. Typically in this scenario, when an order is made the inventory system will record the inventory as already shipped, when in fact the inventory may not be in stock or is still being manufactured. This type of negative inventory is not a problem unless it leads to one of the consequential problems discussed below, because it will be automatically corrected once the inventory does come into stock and is recorded as such.
Anytime something is incorrectly recorded in the supply chain process there is a risk of negative inventory. Because there has been an error, this can potentially be more serious than a timing issue, but only if the underlying cause is not found quickly. One example is where inventory is recorded as being moved from the wrong location such as a different warehouse. If that incorrect warehouse has less than the level of inventory meant to be transferred from the correct warehouse, it may show as having a negative balance of that item. Another situation is where a transaction with an outside party is recorded wrong, for example a sale recording ‘100’ rather than ‘10’ units being sold. This is potentially more serious than the warehouse example, where the total balance will be unchanged, because this type of mistake will cause your total inventory for that item to be incorrect.
The problems caused by negative inventory can be analyzed over the short and long term. In the short term, problems can occur if having a negative balance triggers any events in your inventory system that are unwanted. For example, you may choose not to hold some items in stock but instead order them from a supplier when a customer makes an order (i.e. when you have a negative balance). If your inventory system automatically orders stock when the balance becomes negative, then if there is a recording error, you could end up ordering unwanted inventory. This is especially problematic if this inventory is expensive, difficult to store, or infrequently sold. Worse, if the product ordered by mistake needs to be manufactured from other smaller parts, the incorrect negative balance could trigger a ripple effect down the supply chain and cause many other items to be unnecessarily produced. Another possible effect is that your inventory system may not be capable of handling a negative balance at all, in which case it could malfunction or crash.
In the long term, recording errors will be a problem if they are not picked up. This could affect your purchasing decisions, planning, or evaluations, all of which may not seem disastrous in the short term, but ultimately could have a much larger negative financial and strategic impact on your business than the one-off effects above.
What to do/what not to do
Despite the serious consequences outlined above, the first important thing to remember is not to panic. This may sound clichéd, but in order to remedy negative inventory it is absolutely essential that you find the root cause of the negative balance before taking action. Acting prematurely, such as by manually adjusting your balances when the negative comes from a simple timing issue, will create a new problem rather than solve an existing one.
This applies to recording errors too. If your warehouse has a negative balance for an item for example, it could be because you have wrongly recorded moving inventory between warehouses, or because you recorded too many items as being sold. Or, it could be because you incorrectly readjusted after a stock take. Choosing the wrong error will not only create a new problem when you incorrectly adjust, but it will leave the original problem unsolved.
The best approach is to check for the error using several methodologies, and make sure that they all point to the same error. Only then should you reverse the recording error as necessary.
The role of inventory management
Negative inventory can occur in any inventory management system, no matter how sophisticated. It could even be produced deliberately: like in the example above where negative inventory is a trigger for ordering rarely purchased or difficult-to-hold stock. From an inventory management perspective, the best thing you can do about negative inventory is understand how it occurs within your system, and how you plan to deal with it. In the event that unexplained negative inventory does occur, inventory management software that allows you to view and control your inventory in real-time is the best type of system to deal with this. If your current system does not allow real-time visibility, this may be worth exploring.
NOTE: Unleashed does NOT recommend using negative inventory!