Because inventory is closely tracked using computer systems, different accounting methods, etc. mistakes in the process can actually cause a negative inventory balance. Here are several head-aching issues causing the balance on records to go into the red.
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Timing
First, as new inventory is ordered, the shipment of the inventory may be recorded completely before it is even out of production leading to a negative balance. This is the result of a processing delay, not an error. For example, a company receives a shipment from a supplier that is immediately shipped to a customer. Also, they enter the shipment to the customer into the inventory tracking system in advance of recording the inbound shipment from the supplier, then it will make the initial inventory less than the true quantity temporarily. Thus, the inventory count will be less than zero until they enter the supplier shipment into the system.
Second, invoicing prior to shipping goods caused by a simple processing delay, usually when a customer makes an order. Typically, when an order is made, the inventory system will record the inventory as already shipped; in actual fact, the inventory may not be in stock or is still being manufactured. This type of negative inventory will be automatically corrected once the inventory does come into stock, and is recorded as such.
Production
The production process can be extremely complex as recording. Byproducts, scrap amounts, batch numbers, and production statistics must also be properly tallied. A mistake, duplication transaction, or misunderstanding of an invoice can actually show that more inventory should have been produced than actually was, creating a negative balance that needed to be resolved.
Location
A negative balance resulting from a location difference occurs when a company accidentally ships or records the product to the incorrect warehouse or store. This leads to an excess of recorded products in one place and a negative balance in another area. This can also come from recording wrong numbers of transferred inventory.
Recording
Entry data errors can make negative inventory happen locally. To illustrate, when transferring inventory between two warehouses, an entry mistake of any amount will not change the net combined inventory; however, the inventory count for each warehouse will be offset by the amount of the error. One will have a positive offset while the other will have a negative offset.
Sometimes the negative offset causes a negative inventory record for the affected warehouse.
Some entry mistakes don't balance out at any level and may or may not result in negative inventory. If you subtract out more than is currently in inventory, a negative number will occur. Otherwise, it will be a positive incorrect number, then there is no red flag alerting something wrong. Therefore, knowing the wrong inventory count is better than doing business as usual in ignorance.
What are the effects of negative inventory?
The negative balance of inventory can cause one or more serious consequences below.
Inventory Items have wrong cost leading to incorrect Cost of Goods Sold (COGS) amounts on Profit and Loss or improper COGS of Inventory Assemblies on job costing reports
Since the working capital is defined as current assets minus current liabilities, if inventory went down in the income statement, the working capital would also go up.
Errors in Accounts Payable
Bills for inventory purchases showing up on income and expense reports
Erroneous inventory amount on Balance Sheet
Cash-basis Balance Sheet out of balance
Vendor reports contain errors
In conclusion, it is critical to ensure that the inventory shown in financial statements is accurate because it helps people make better financial forecasts as well as the right business decision.
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