Guide: How to Conduct Stock Audits Effectively

In the professional world—especially in bank-assigned audits—a stock audit is far more than merely counting stock. It is a comprehensive assessment of the primary security against which the bank has extended credit. A well-conducted stock audit safeguards the bank’s interests and reflects the auditor’s professional judgment and experience.

Before starting any audit, the first and foremost step is to understand the status, operating structure, and environment of the auditee. The audit environment determines how the audit should be planned and executed.

Basic but important aspects that need to be understood first to plan your audit:

• Operating Structure – Proprietorship, Partnership, LLP, or Company (this defines governance, disclosures, and control levels).
• Nature of Activity – Manufacturing, Trading, or Service
  • Manufacturing: WIP valuation risks
  • Trading: Inventory rotation risks
  • Service: Consumables and receivables focus
• Number of Units / Branches – Multiple locations increase reconciliation and control risks.
• Banking Arrangement – Sole banking or multiple/consortium banking (critical for DP allocation).
• Accounting & Inventory Software – ERP/manual systems determine data reliability.

Some of these details are available at the time of audit allotment, while others should be discussed during the initial interaction with the borrower.

Further as we know that the stock audits are majorly bank-assigned audits and the good thing is every bank has its pre-defined formats, under which any stock auditor needs to prepare the Stock Audit Report (SAR). Therefore Key documents to review:

1. SAR Format Review: First we need to go through the format of SAR and accordingly decide the requirement to be raised from the borrower or banker.

For example, some banks need banker inspection and income from accounts in SAR. Similarly, some bankers require DP calculation for Visit data and audit cut-off date, i.e. end of last month DP calculation.

2. Document Review: The “Sanction Letter” is Your Bible,

Therefore, one should to go through the terms of sanction letter  to ascertain:

• Stock and Debtor eligibility. Usually, debtors older than 90 days & Slow moving are excluded, again as stated,it also depends onthe  nature of the business
• Margins required for DP calculation.
• Treatment of Related Party transactions.  , mostly related party debtors  excluded from DP until specifically allowed inthe  sanction letter

3. The Site Visit: At the time of the visit stock audit does not mean only counting stock. During the visit, you must ensure the following:

1. Identity & Statutory Check: The borrower’s name board must be displayed along with the GST number. Obtain the GST certificate and review the Electricity Bill to verify the registered address.

2. Valuation & Ownership: Select samples and trace them back to Purchase Invoices to ensure the goods actually belong to the borrower and verify the value of goods considered in the stock statement for DP.

3. Operational Review: Review the last 3–4 electricity bills to understand the operations. This is vital for manufacturing or entertainment companies (e.g., Water Parks, Amusement Parks) to verify actual activity levels.

4. Finished Goods: Review Sales Bills to ascertain the genuineness and valuation of finished goods lying in stock.

5. Movement Reconciliation: Since audits usually happen mid-month, perform a Back-Reconciliation.

Example: If you visit on Dec 22nd, take the Nov 30th statement and adjust for Sales/Purchases from Dec 1st to Dec 21st to arrive at the “book stock” on the visit date.

6. Quality & Sampling: Select samples for large-value and large-quantity goods to ensure quality.

7. WIP & Consumables: Check the valuation method for Work-in-Progress (WIP), as this is where errors are most common. Review Consumables, as many are held for long periods and may be obsolete.

Slow-Moving Stock: Ask for a one-year movement report. If unavailable, identify slow-moving stock by observing the physical condition of goods lying on the premises.

For example, Dust-covered stock or rusted items are signs of obsolescence that shouldn’t be in the DP

Evidence: Ensure photos are Geo-tagged with date and time stamps. This is a non-negotiable requirement for bankers.

4. Financial Analysis & Drawing Power (DP) Calculation

This is the “main part” of the report. The bank relies on your DP calculation to ensure the securities are well-covered.

• This is the “core” of the report. The bank relies on your DP calculation to ensure the loan is well-covered.
• Movement of debtors should be checked to ascertain that the ageing of the debtor are correct
• Usually Related party debtors are not allowed for the DP, unless specifically allowed in the sanction; therefore, it is important to ascertain the Related parties, and the same can be checked from the RPT disclosure in case of a company and the Tax audit report in case of a firm/individual.

One should also check the trial balance to ascertain the other liabilities of the borrower and assess the impact of the same on DP

In my experience, the DP (Drawing Power) calculation is the most critical output of this exercise. While I have covered the essential factors, remember that every audit presents unique situational challenges.

So, I have done my best to cover all the important factors in my opinion and as per my experience, for performing a stock audit; however, there are many other things as well which an auditor faces at the time of conducting a stock.

At the end, just remember stock audit is more than counting the stock

Stock audit visit report that I have prepared for my team for internal records