What is an Inventory Audit? 

An internal and external inventory audit is a physical verification of assets and inventory, conducted by internal and external auditors, to verify that inventory records match physical stock while ensuring businesses are compliant with regulations. For example, in the food and beverage industry, businesses need to be compliant with food safety standards set by the UK Food Standards Agency (FSA) or the U.S Food and Drug Administration (FDA). Internal audits also give businesses the opportunity to confirm they’re reporting inventory correctly.  

External audits are conducted by government bodies or independent auditors, such as Financial Reporting Council (UK) or Financial Markets Authority (NZ). All documentation relating to assets and inventory is diligently checked, ensuring that all records are accurate and consistent with the physical items.  

Internal inventory audits should be carried out quarterly or annually.  However, this can vary depending on the type of stock. For example, high-value items, inventory audits should be carried out quarterly. For low-value items, yearly is sufficient.  

External audits are often conducted annually. However, it differs by industry practices and business types. For example, food and beverage businesses typically conduct an external audit quarterly or every six months. Businesses in tech manufacturing may only conduct audits annually. 

Yes, it’s possible to fail an inventory audit. Here are a few common ways businesses fail an inventory audit and how to avoid them.  

Inventory records don’t match

One of the most common errors is inventory records not matching physical stock, leading to financial discrepancies and creating confusion.  

This is caused by:

• Items not being in the correct location 
• Items not being removed from a system once used 
• Barcodes not matching the assigned product

Regular inventory audits help to uncover errors early to avoid disruptions to your business. Ensuring that your staff are well-trained on inventory management software and procedures when handling stock can help to reduce errors in inventory records. 

Misreading numbers 

Another common mistake is misreading product numbers. For example, ‘05’ can be misread as ‘50’, negatively impacting an inventory audit.  

Misreading numbers happens when: 

• Rushing through audits 
• Not double-checking product numbers  
• Barcodes being scanned incorrectly 
• Numbers being one digit off 

A second verification process while logging count is a straightforward way to minimise the possibility of misreading numbers. Reducing manual data entry through barcode scanning ensures labels aren’t being misread. 

Incorrect labelling

Products that are incorrectly labelled can cause headaches during an inventory audit. For example, if a box is labelled with the wrong quantity, this can lead to stock discrepancies, delays in order fulfilment, and inaccurate financial reporting.

Incorrect labelling is caused by: 

• Errors at the warehouse before products are dispatched 
• Contents not being verified by employees  
• Assumptions made based on labelling 

Employees shouldn’t rely on labels, and boxes must be opened and verified before being placed in the assigned location. Smart features, such as RFID tags, can be used to avoid human errors during manual entry.  

Not verifying inventory counts

Shortcuts, such as not verifying the inventory count, are often taken to get the product out quicker. However, this can lead to major financial losses, especially with high-value items.  

This can happen when: 

• Relying on old and outdated inventory records 
• Multi-counting of stock 
• Inventory management systems are not being updated regularly

Inventory counts must be checked against physical stock to avoid inaccuracies. Barcode scanning allows for your inventory management software to be updated in real-time, ensuring the number matches physical stock. Regular internal inventory audits help to reduce discrepancies between your physical stock and reported numbers. 

While there is no legal punishment for failing an external inventory audit, it can harm your business, including losing investors’ confidence to firing key personnel.  

Failing an internal audit highlights key issues, giving you a chance to address them before an external review. 

If your business fails an external inventory audit, you will receive feedback outlining the next steps. Usually, a follow-up audit will be conducted to ensure all feedback has been taken on board and measures have been implemented to improve your inventory management.  

When it comes to auditing your inventory, it’s important to pick a method that suits the reason behind the audit and who's carrying it out. Whether you're doing a quick internal check or preparing for an external review, the approach should match your business needs. Below are some of the most common inventory audit procedures to keep things accurate and running smoothly. 

Physical Inventory Count  

A physical inventory count is an inventory system ensuring that reported stock matches the physical stock. There are four types of inventory counts: periodic, cycle counting, tag counting and spot counting.

• Periodic Counting: This method involves counting all inventory at scheduled intervals, often monthly, quarterly, or annually. It typically requires a full shutdown of operations to ensure accuracy and is commonly used in smaller businesses. 
• Cycle Counting: Inventory is counted continuously on a rotating schedule, focusing on specific items or categories each time. This method minimises disruption and helps maintain ongoing accuracy, making it ideal for businesses with large inventories. 
• Tag Counting: Items are tagged with count labels during the physical inventory process. Counters record quantities on these tags, which are then verified and adjusted. This method is useful for ensuring accountability and traceability during audits. 
• Spot Counting: Also known as ad-hoc or random counting, this involves checking specific items or locations without a set schedule. It’s often used to verify discrepancies, investigate issues, or perform quick checks on high-value or fast-moving items. 

  ABC Inventory Analysis

ABC inventory analysis is a categorisation method based on the inventory value and its importance to the business, allowing them to prioritise inventory control methods and focus on essential items. The ABC inventory analysis is broken up into three categories: 

• A: Most important and high-priced items  
• B: Moderate-cost items  
• C: Low-cost items 

Cutoff Analysis 

Cutoff analysis is a subdivision of physical inventory analysis. Allowing you to pause operations to physically count all items in the inventory, cutoff analysis enables businesses to get a more accurate count while reducing uncontrolled variables (inventory costs, supply chain efficiency and demand).  

Analytical Procedures  

Through item data – including profit margins and unit costs – view any sudden changes in your inventory. Analytical procedures allow you to determine if there’s been any growth or change based on data from prior years.  

Overhead Analysis 

An overhead analysis is an audit of the indirect costs associated with product manufacturing and inventory, including insurance, factory rent and utilities and communication systems. This helps businesses understand the true cost of holding and producing inventory, making it easier to manage budgets and improve profitability. 

Finished Goods Cost Analysis  

Often used in production or manufacturing, a finished goods cost analysis counts the inventory of manufactured products rather than the individual parts. Finish goods cost analysis gives a clearer picture of the value of sellable stock, helping with pricing strategies and financial reporting. 

Freight Cost Analysis  

Freight cost analysis measures the cost of shipping out your finished products by looking at the delivery costs and lead times when transporting items. It may calculate any inventory losses or damages during transit. It helps identify inefficiencies in the supply chain and opportunities to reduce shipping costs or improve delivery performance. 

Shipping Invoice Matching  

Shipping invoice matching, often done at random, ensures that a business’s costs stay consistent and that they are paying the right amount for transporting inventory.  

Product Reconciliation 

Product reconciliation compares the physical inventory counts with your inventory records to find any discrepancies, helping you to also find the source of the inaccuracies. It helps maintain data accuracy, reduces shrinkage, and highlights areas where processes may need tightening. 

Inventory Audit Best Practices 

Inventory audits don’t need to be stressful. With a structured approach and the right tools in place, they can become a valuable part of your business operations. Here are three key practices to help ensure your audits run efficiently.

1. Implement a consistent audit schedule  

Rather than waiting for issues to arise, establish a regular audit routine, whether that’s monthly, quarterly, or annually. The ideal frequency depends on your inventory turnover and business size, but consistency is key. Regular audits help identify discrepancies early and maintain accurate, up-to-date inventory records. 

2. Use an inventory management system to simplify the process 

Manual audits are time-consuming and prone to error. An inventory management system with inventory tracking, automated reporting, and cloud hosted makes audits far more manageable. You’ll save time, reduce mistakes, and gain clearer insights into your stock levels, especially as your business grows and customer demands increase. 

3. Invest in team training 

Make sure your team is confident when using your systems and understands your audit procedures. Ongoing training, updates on new features, and sharing best practices will help ensure everyone is aligned and working efficiently. 

How Unleashed Can Make Inventory Audits Easier 

When it comes to inventory audits, having the right tools in place can make all the difference. Unleashed’s Inventory Management Software is designed to give businesses full visibility and control over their stock, making internal audits faster, more accurate, and far less stressful. With real-time tracking, automated reporting, and cloud-based access, you can easily verify stock levels, identify discrepancies, and maintain clean, audit-ready records. 

For businesses looking to take things a step further, Access Evo, Unleashed’s AI-powered inventory management solution, adds an extra layer of intelligence. With Copilot and Feed, Evo helps you spot trends, predict stock movements, and flag anomalies before they become issues. These insights are valuable when preparing for external audits, as they ensure your data is not only accurate but also backed by predictive analytics. 

Simplify your inventory audits with Unleashed. Start your 14-day free trial today!