This article was updated in March 2023 to reflect new definitions and current industry data.
Inventory control can be adversely affected by inaccurate inventory records stemming from negative inventory. Negative inventory refers to the situation which occurs when an inventory count suggests that there is less than zero of the item or items in question.
Below we summarise the key factors that may cause a negative inventory balance and discuss how these can affect your business.
What is negative inventory?
Negative inventory is the gap between your actual on-hand inventory and the stock recorded in your inventory system.
In most instances, negative inventory is self-correcting: a temporary misalignment of inventory level reporting and actual levels on the ground.
However, in some cases a negative inventory can lead to a negative supply-chain reaction. The difference lies in understanding the causes of the negative inventory and what steps, if any, need to be taken to rectify the situation.
Negative inventory isn’t necessarily a bad thing, but knowing how and why it occurred is very important.
What leads to negative inventory?
When inventory is tracked with computer systems, various mistakes in the process may result in the display of a negative inventory balance. The single cause of this must be identified to encourage smooth flowing inventory management.
1. Report timing
One thing that can cause a negative inventory balance is timing.
This can occur when the shipment of inventory has prematurely been recorded as complete, when in reality it may still be in the production stage.
In this case the negative balance is the result of a delay in processing rather than an error so the issue must be rectified in future to prevent confusion.
2. Production issues on inventory control
A negative balance can also occur during the production process if production records do not match up to the actual amount of inventory produced.
This can occur when, for example, invoices are misunderstood or unclear, or when an accidental duplication of a transaction is made. In this situation ‘ghost inventory’ and a negative balance may appear.
For better inventory control, businesses need to identify the mistake in the production process.
3. Location of different warehouses
A negative balance can also occur when the same types of inventory are located in different warehouses. A negative balance can easily occur here when an order is made for goods from the wrong location, resulting in inaccurate inventory records.
This is called a location-level negative balance.
4. Item-level negative inventory
A more serious type of negative balance is an item-level negative balance, which is primarily the result of transactional error.
For example, say that warehouse ‘A’ stocks 200 units of an item in question and warehouse ‘B’ stocks 100 units of the same item.
Now, imagine that a shipping order is made for 100 units to be shipped out from location ‘A’. When the same order is processed through the system, the units are mistakenly taken from warehouse ‘B’ rather than ‘A’.
The result is a deficit of the location-level inventory at location ‘B’, when in fact there are still 100 units remaining at that warehouse.
To add to the confusion, the item-level inventory is accurate given that there are still 200 units; 100 units are simply in the wrong location.
This type of transactional error can have huge knock-on effects. If staff do not identify the error, they may order extra stock to make up for the perceived lack of inventory. This can result in overstocking, which has obvious financial consequences for the firm.
Knowing the causes and potential risks of negative inventory can help you secure your business against them.
Reducing the occurrence of negative inventory
Complications occur when a business fails to pick up on negative inventory, consequently relying on stock that is not actually there. Undertaking regular checks, or by using accurate real-time inventory systems, will usually identify an error before any real problems arise.
The use of barcode scanners and automated inventory systems will also help to reduce the risk of negative inventory.
Due to the far-reaching impact of negative inventory errors, whenever a negative balance appears it is essential that your firm looks closely at the problem in order to identify the source.
These types of errors are often easy to rectify if taken care of immediately, before one error leads to significant understocking or overstocking, which can have adverse effects on inventory control.
