Counting your inventory correctly is critical because it’s used to calculate one of the most important financial indicators for some types of business - Cost of Goods Sold (COGS). Specifically, the calculation of COGS is beginning inventory (what you already had) plus purchases during the period (what you bought new and added to the beginning inventory), less ending inventory (what you have left). So, you can see that if your inventory count is incorrect, your COGS won't be accurate either! In some businesses, COGS accounts for one third of the total business expenses, so it is important to have a good handle on these costs. In addition, monitoring your COGS is a good way to identify operational problems within your business.
The first step to monitoring your COGS is to create a target for COGS as a percentage of income. For restaurants, a target COGS percentage is often 30-35% of sales. If your COGS are significantly higher than your targeted percentage, you might want to look at your menu pricing. It is likely that you need to raise your prices to achieve the desired target. If your COGS is significantly lower than the estimate you had anticipated, you may want to find out what others in your industry are seeing, review your books to make sure you are capturing all expenses appropriately and finally consider whether reducing prices would in fact increase revenue via a significant increase in overall sales.
Once you are consistently able to meet your target, your business can be diligent in identifying meaningful changes to COGS. Increases in COGS could be due to many variables, including employee theft, incorrectly preparing product, or waste. The good news is that once you identify a problem, you can set up controls to minimize these losses. Some businesses are even able to set targets for specific categories of COGS. Using these fine tuned targets will allow you to easily and quickly find areas of concern. For instance, a restaurant might define their COGS as Food, Beverage, Paper and Liquor. Each category then holds a certain percentage of total Product COGS. When a particular category, such as paper products, consistently exceeds the expected percentage, the restaurant knows they need to pay closer attention to the use of these items or shop around for better priced paper products. Tracking liquor sales separately could even highlight when too many drinks are comped by the bartenders.