Tracking inventory
is essential for business success, but many owners overlook the key steps the business must take before setting up a system. While it may seem as simple as knowing what’s in stock, inventory tracking plays a much more significant role in business operations. It directly impacts financial accuracy, resource management, and overall efficiency.
A weak inventory system can lead to over-ordering, shortages, and misplaced materials, increasing costs and causing delays. However, business owners must ensure their accounting practices are in order before setting up any inventory tracking system. Failing to do so can lead to financial discrepancies, misreported stock levels, and cost ineffective.
A critical first step in preparing for inventory tracking is reviewing Profit and Loss (P&L) statements and balance sheets. These financial documents provide an overview of business performance and highlight potential concerns, such as excessive spending, declining profit margins, or cash flow problems. Understanding these reports is essential, as they are the foundation for making sound financial decisions.
Unfortunately, many business owners either overlook these financial statements or struggle to interpret them correctly, leading to errors in tracking expenses and revenue. If you do not understand financial reporting well, setting up an inventory tracking system can be hard. This can lead to messy records and wrong stock levels, which can hurt the business.
Why Inventory Tracking Matters
There are two primary reasons why a business owner may want to track inventory:
- To maintain visibility of stock levels, Ensuring the business has the right materials on hand helps prevent shortages and minimize losses due to theft, waste, or mismanagement.
- To align inventory tracking with financial reporting – Proper inventory tracking ensures that financial records accurately reflect the business’s current assets and prevent discrepancies that could cause financial strain.
While inventory tracking offers multiple advantages, not every business has the infrastructure or operational need to implement it effectively. Some businesses may find that the time and resources required to track inventory do not justify the benefits. For smaller companies, tracking inventory may become an unnecessary burden rather than a helpful tool.
The time investment can be substantial even if a business owner only wants to track available stock. Business owners need to evaluate whether their inventory volume justifies the effort involved. Many business coaches and financial advisors encourage business owners to track inventory regardless of their company’s size.
However, not all businesses benefit equally from rigorous inventory tracking. Small business owners must assess whether implementing a tracking system is worth the time and labor investment.
For instance, many small business owners purchase materials for specific jobs as needed rather than maintaining a large stockpile of supplies. Take a small HVAC company, for example—during peak summer months, they may keep a handful of extra air conditioning units on hand to meet customer demand quickly.
Similarly, an electrician anticipating rising generator prices may choose to stock up on a few units in advance. While these strategies help ensure material availability, they do not necessarily require extensive inventory tracking. A simple inventory log or occasional stock checks may be sufficient in such cases, rather than implementing a complex tracking system.
When Should Businesses Consider Inventory Tracking?
Business owners should evaluate company size, operations, and available time before implementing an inventory tracking system. Generally, inventory tracking becomes more beneficial when a business expands beyond a single-location operation or has multiple service vehicles operating simultaneously.
For instance, when a company grows to three or more vehicles, inventory tracking becomes more practical due to the increased movement of materials. At this scale, technicians complete multiple jobs daily, requiring a consistent stock of essential supplies like circuit breakers, fittings, or other frequently used components. Without tracking inventory properly, businesses risk running out of critical materials, leading to job delays and customer dissatisfaction.
Even as tracking becomes necessary, owners must decide if managing inventory is worth the time investment. Many small service-based businesses, such as HVAC, plumbing, or electrical companies, often have only a handful of employees handling administrative tasks, including scheduling appointments, collecting payments, and managing customer inquiries. An important question arises: “Who has the time to track inventory?” If the business has limited office staff, implementing a detailed tracking system may be more trouble than it’s worth.
Inventory Tracking and Financial Accuracy
Inventory tracking is more than simply recording what materials have been purchased and used. Inventory tracking must be integrated with accounts payable and invoicing systems to ensure financial accuracy.
Small businesses may not focus as much on tracking accounts payable because they often pay their bills in full at the end of each month. However, as businesses grow and transactions become more frequent. The accurate tracking of accounts payable becomes essential to maintaining a clear financial picture.
Similarly, inventory tracking must be aligned with invoicing and revenue recognition. Every time a piece of material or equipment is used for a job, it should be deducted from the inventory account in real-time. If materials are not correctly tracked when used, the business risks financial discrepancies, leading to either overestimating or underestimating available stock. Various inventory management systems are available to help with this process, but each requires a consistent, disciplined approach to tracking materials from purchase to usage.
When businesses purchase inventory, those materials should be recorded as an inventory asset on the balance sheet. When materials are used, the inventory account must be adjusted to reflect the stock depletion. Without this process, businesses can easily lose track of materials. This can cause inefficiencies, higher costs, and possible losses from theft or mismanagement.
Is Inventory Tracking Always Necessary?
For companies generating between $300 million and $500 million monthly sales, inventory movement is significant enough to justify hiring a dedicated warehouse manager. At this scale, inventory tracking is not just beneficial—it’s essential for maintaining operational efficiency.
However, inventory tracking software may not be as necessary for smaller businesses with lower sales volumes. In such cases, the responsibility often falls on the business owner, which can be time-consuming and challenging. Business owners must assess whether tracking inventory aligns with their business model and operational capacity.
The Financial Impact of Inventory on Taxes
Another critical factor is that inventory is not a business tax write-off until it is physically used. Many business owners assume that purchasing inventory immediately reduces taxable income, but inventory is considered an asset until it is sold or consumed.
A company has $100,000 in inventory at the end of the year. This inventory is stored in a warehouse. The company cannot deduct this amount as an expense on its tax return for that year. Instead, it remains on the balance sheet as an inventory asset and becomes a deductible expense once the materials are used for a job or sold to customers.
This distinction is crucial for businesses that carry large amounts of inventory, as it affects financial planning and tax liabilities. Business owners need to track inventory levels closely. This helps ensure that financial statements are accurate. It also prevents unexpected tax issues from unused stock.
Key Steps to Prepare for Inventory Tracking
Before implementing an inventory tracking system, business owners must ensure that their financial reporting is structured properly. There are three essential steps to take before diving into inventory management:
Optimizing the Profit and Loss (P&L) Statement
The first step is ensuring that the P&L statement (income statement) is formatted correctly. Correct formatting allows a clear breakdown of revenue and expenses.
Materials and supply costs should be categorized to align with how to track inventory in real time. A clear P&L statement helps business owners understand how material costs impact profits. It also keeps financial reports accurate.
Setting Up a Solid Accounts Payable (A/P) Tracking System
The next step is establishing an efficient accounts payable ap system to track every bill received and every payment sent to vendors. Without a structured A/P process, business owners risk losing track of material costs, leading to discrepancies in financial records.
The A/P system should have a way to log all vendor invoices. It should track outstanding balances and match payments with financial statements. A/P ensures that all inventory purchases are accounted for and that financial reporting remains consistent.
Integrating Inventory Tracking with Invoicing
Once the P&L statement and accounts payable system are in place, the next step is integrating inventory tracking with invoicing. A sound inventory system should sync with invoicing to update stock levels automatically with each sale or job. Updating stock levels makes sure that when materials are used, they are taken from the inventory account. This also moves them to the profit and loss statement as an expense.
Without this integration, businesses may struggle with inaccurate physical inventory counts, leading to incorrect financial reporting and potential cash flow issues. Finding inventory management software solutions that allow seamless communication between inventory management and invoicing is essential for maintaining an organized and efficient tracking system.
Final Thoughts
Inventory tracking can be a powerful tool for managing a business efficiently, but it isn’t a one-size-fits-all solution. Before implementing an inventory system, business owners should evaluate their financial structure, company size, and available resources. By knowing the right level of tracking for their business, they can avoid extra complications. This way, they will have the right materials ready when needed.
Check out our youtube video Inventory Tracking for Contractors and What to Consider with James to give you a first hand recap.If you are still determining which plan works best for you or need additional help or have any questions, Waterford Business Solutions is happy to help. Feel free to call us at 864-351-0852 or email us at Info@WaterfordBusiness.com.
