Inventory reconciliation for e-commerce: reconcile physical counts to book records

Why Inventory Reconciliation Matters for Your Business

Your Shopify dashboard shows 100 units of your top-selling SKU, but your warehouse team can only find 92 on the shelf. This gap isn't just an operational nuisance; it is a direct threat to your bottom line. It leads to overselling, canceled orders, and damaged customer trust. On the financial side, it means your reports are wrong, misstating the value of your assets and eroding your gross margin. For e-commerce founders in the Pre-Seed to Series A stages, the disconnect between digital records and physical reality quietly drains cash flow and credibility.

Learning how to reconcile inventory counts in ecommerce is a foundational skill for building a scalable and profitable business. See our Inventory & Fulfilment Cost Accounting hub for more. The goal is not just to fix the numbers but to create a reliable system that keeps them permanently in sync, providing accurate data for operational and financial decision-making.

Understanding Book vs. Physical Inventory

At its core, inventory reconciliation is the process of ensuring your recorded inventory matches your actual, physical inventory. It is essential to understand that these two numbers represent different things.

• Book Inventory: This is the quantity your system of record, like Shopify or a dedicated inventory management system, says you should own. It is a calculated figure, updated by sales, purchase orders, and returns.
• Physical Inventory: This is the tangible count of what is actually on your warehouse shelves, confirmed by a manual count. It is the ground truth.

When these two figures do not align, you have an inventory discrepancy. This discrepancy has a direct financial impact that flows through your company’s financial statements.

The Financial Impact of Inventory Discrepancies

On your balance sheet, inventory is recorded as a current asset. When an item is lost, stolen, or damaged and cannot be sold, its value must be removed from the asset column and recognized as an expense. This process creates what is known as inventory shrinkage, which is recorded under Cost of Goods Sold (COGS) on your income statement. This adjustment, known as an inventory write-off, directly reduces your gross profit and net income for the period. For a startup managing cash flow and reporting to investors, understanding this link is crucial for accurate financial planning.

How to Reconcile Inventory Counts with Cycle Counting

Many businesses default to a massive, once-a-year physical inventory count. This often requires shutting down the warehouse for a weekend, pulling the entire team into a tedious manual process that disrupts fulfillment and sales. For a fast-moving e-commerce startup, this level of disruption is impractical and inefficient. What founders find actually works is a more continuous and less disruptive method: cycle counting.

The cycle count process involves counting small, specific subsets of your inventory on a rotating, regular schedule. Instead of counting everything at once, your team counts a few SKUs every day or every week. This approach makes the task manageable, integrates it into normal warehouse operations, and provides a constant pulse on warehouse inventory accuracy without halting shipments. The key to an effective cycle count process is prioritization, which is best achieved through ABC analysis.

Prioritizing SKUs with ABC Analysis

ABC analysis is a method of categorizing inventory that applies the 80/20 rule, which suggests that a small number of your items typically account for the majority of your sales value. By categorizing your SKUs, you can focus your counting efforts where they matter most.

• 'A' Items: These are your superstars. 'A' items are the top 10-20% of SKUs that represent approximately 80% of sales value. Because they are your most valuable and fastest-moving products, they require the most frequent attention. The recommended counting frequency for 'A' items is monthly.
• 'B' Items: These are your middle-of-the-road products. They represent a moderate portion of your inventory value and sales volume. The recommended counting frequency for 'B' items is quarterly.
• 'C' Items: This is the long tail of your inventory. These items sell infrequently and represent a small portion of your total inventory value, even though they may make up a large number of your total SKUs. The recommended counting frequency for 'C' items is once or twice a year.

By implementing this prioritized approach, you focus your limited resources where they have the greatest financial impact. This system allows you to maintain high accuracy on the SKUs that drive your business without the operational drag of a full shutdown, making it one of the most effective physical inventory best practices for a growing company.

Stock Adjustment Procedures: Recording Discrepancies Correctly

Once a cycle count reveals a discrepancy, you must adjust your financial records. This step is critical for ensuring your financial statements accurately reflect your company's performance and position. Following proper stock adjustment procedures is essential for maintaining financial integrity and providing reliable data to investors, lenders, and internal teams.

Step 1: Calculate the Adjustment Value

First, calculate the financial impact of the discrepancy. The calculation is straightforward. The formula for adjustment value is: (Book Quantity - Physical Quantity) x Item Cost. For instance, if your accounting system shows 150 units of a product with a cost of $20 each, but your physical count confirms only 145, the adjustment value is (150 - 145) x $20, which equals $100. This $100 represents the value of your inventory shrinkage.

Step 2: Record the Journal Entry

Next, you must record this adjustment correctly in your accounting software. This involves a specific journal entry that moves the value from an asset account to an expense account. Both US GAAP and UK FRS 102 follow the same core principle of recognizing the loss in the period it is discovered.

The Correct Journal Entry

For inventory shrinkage, when you have fewer items than the books show, the journal entry is a Debit to Cost of Goods Sold and a Credit to Inventory Asset. This increases your expenses (COGS) and decreases your assets (Inventory).

For inventory overage, in the rare case you find more items than expected, the journal entry is a Debit to Inventory Asset and a Credit to Cost of Goods Sold. This increases your assets and decreases your expenses.

In practice, you would make this entry in your accounting system. For US companies using QuickBooks, you can use the “Inventory Quantity Adjustment” feature, ensuring the adjustment account is mapped to a Cost of Goods Sold account. For UK companies using Xero, this is handled through a “New Adjustment” under the Inventory section, where you would similarly assign the adjustment to a COGS account. For specific UK VAT treatment of lost or damaged goods, consult the GOV.UK guidance.

Resolving Inventory Discrepancies: Finding the Root Cause

Adjusting the numbers is only half the battle. The other half is understanding why the discrepancy happened in the first place to prevent it from recurring. Resolving inventory discrepancies requires investigation. In day-to-day finance operations, what actually happens is that discrepancies are symptoms of small, repeated process breakdowns. For a growing e-commerce company, the root cause typically falls into one of these four categories.

• Receiving Errors: The initial count when inventory arrives from a supplier is often incorrect. A box might be marked as containing 50 units but only has 48, or an entire carton is missed during intake. This error carries through the system until the first physical count reveals the shortage.
• Fulfillment Errors: The wrong item or wrong quantity is picked and shipped to a customer, but the system deducts the item that was supposed to be shipped. This common mistake leaves you with one SKU over its expected count and another one short.
• Unrecorded Removals: Items are often removed from sellable stock for legitimate reasons that are not recorded in the system. This includes products pulled for marketing photoshoots, samples sent to influencers, or damaged goods that were discarded without being properly written off.
• Returns Mismanagement: A customer returns a product that is in perfect condition to be resold. A warehouse team member places it back on the shelf but forgets to scan it back into the inventory management system. The physical stock increases, but the book stock does not, creating an overage.

After your cycle count identifies a problem SKU, use this list as a diagnostic checklist to investigate and find the source of the issue. Fixing the underlying process is the only way to achieve lasting warehouse inventory accuracy.

Scaling Your Inventory Reconciliation Process as You Grow

For early-stage e-commerce founders, mastering inventory reconciliation is not just an accounting exercise; it is a core competency for building a scalable business. The path forward involves moving from disruptive annual counts toward a continuous, data-driven cycle count program. This system provides the accuracy needed to prevent overselling, avoid stockouts on key products, and produce reliable financial statements. While perpetual inventory systems are an alternative, as detailed in our Real-Time Inventory Tracking guide, a strong manual reconciliation process is the first step.

The way you implement this system can evolve as your company grows.

• Pre-Seed / Bootstrapped ($0-1M Revenue): At this stage, your process can be simple. A well-organized spreadsheet for your ABC analysis and count schedule, combined with data from Shopify, is often sufficient. The priority is to establish the discipline of regular counting. Focus on perfecting the process for your top 10-20 'A' items first to protect the core of your revenue.
• Seed / Series A ($1-5M+ Revenue): As order volume increases, spreadsheets become a liability. They are prone to manual error, lack real-time updates, and do not provide a sufficient audit trail. At this point, you should invest in a dedicated inventory management tool that integrates with your e-commerce platform and accounting software, such as Katana, Cin7, or QuickBooks Commerce. Your cycle counting should be a formal, documented process managed within that system.

Ultimately, understanding how to reconcile inventory counts in ecommerce is about creating a reliable feedback loop between your physical operations and your financial data. By implementing a systematic approach, you build a more resilient, predictable, and profitable business prepared for the next stage of growth. Continue building your expertise at our Inventory & Fulfilment Cost Accounting hub.

Frequently Asked Questions

Q: How can I perform cycle counts without disrupting my shipping schedule?
A: The key is to integrate small, frequent counts into daily operations. Count a few SKUs during natural lulls in activity, such as the beginning or end of a shift. Since you are only counting a small subset of inventory, it rarely requires pausing fulfillment and avoids the disruption of a full warehouse shutdown.

Q: Is a full physical inventory count ever necessary if I do cycle counts?
A: Yes, a full physical count may still be useful annually. Many companies use it to establish a clean baseline before implementing a new inventory system. It can also be required by auditors or lenders to verify asset values for financial reporting. However, regular cycle counting makes this annual event much faster and more accurate.

Q: What is the difference between an inventory write-off and a write-down?
A: An inventory write-off removes the full value of lost, stolen, or unsellable inventory from your books, as described in this article. An inventory write-down reduces the book value of inventory that has lost value but is still sellable, for example, due to obsolescence or falling market prices. Both are stock adjustment procedures that impact COGS.