What type of business would be an example of a perpetual inventory system?

What differentiates a periodic from a perpetual inventory management system, and which makes the most sense for your company? Most small businesses still use periodic inventory management, although perpetual inventory management has become increasingly popular due to the development of more sophisticated computer scanning of inventory, lower software costs, and increased software functionality.

More and more businesses use barcode scanners at the point of sale. According to generally accepted accounting principles (GAAP), companies can choose to use either a periodic or perpetual inventory system.

Understanding the difference between the two systems can help you figure out which method works best for your business.

Periodic Inventory System

Periodic inventory management allows a company to track its beginning inventory and ending inventory within an accounting period, but it does not track the inventory on a daily or per-sale basis. These companies track their inventory by having employees take a physical inventory count.

Under this system, companies record all purchases to a purchases account. Once the physical inventory on hand has been counted, the balance in the purchases account is shifted into the inventory account, which in turn is adjusted to match the cost of the ending inventory.

You can calculate inventory costs, or cost of goods sold, under the periodic inventory system as follows:

Beginning inventory + Purchases = Total cost of inventory (goods)
Total cost of inventory – Ending inventory = Total cost of goods sold

Companies calculate the cost of ending inventory by using the LIFO or FIFO inventory accounting methods, or other less common methods. Beginning inventory simply equals the ending inventory from the previous time period.

Business types using the periodic inventory system include companies that sell relatively few inventory units each month such as art galleries and car dealerships. Additionally, smaller companies that don't have the staff to work with a perpetual system often use the periodic inventory system until they get to a point where the benefits of a perpetual inventory system outweigh the costs of installing the system.

Perpetual Inventory System

A perpetual inventory tracking system records adjustments to inventory balances after every transaction through point-of-sale inventory systems.

This eliminates the need for the store to close down for a physical inventory stock-taking as perpetual inventory systems allow for continuous stock-taking. Perpetual inventory systems keep a running account of the company's inventory that updates after every item sale or return.

Perpetual inventory systems involve more record-keeping than periodic inventory systems, which takes place using specialized, automated software. Every inventory item is kept on a separate ledger.

These inventory ledgers contain information on the item's cost of goods sold, purchases and inventory on hand. Perpetual inventory management systems allow for a high degree of control of the company's inventory by management.

Perpetual inventory systems provide the business owner with a record of detailed sale transactions by item, including where, when, and at what price items were sold. As a result, businesses can have inventory spread over more than one physical location while maintaining a centralized inventory management system.

Even with a perpetual inventory management system, the company still needs to shut down at least once each year to do a periodic, manual inventory count.

The scanned barcode sales data tell the business owner exactly what inventory should still be on hand. The company then compares the manual periodic inventory count results to the periodic data to determine how much inventory has been lost, stolen, damaged or subject to spoilage.

Perpetual vs Periodic Inventory Management

If your business is small, using periodic inventory management may work for you because you can operate with just a cash register and simple accounting procedures.

If you sell services rather than products, you may not need an inventory management system at all, unless you also have inventory such as food items, for a restaurant, or you are in the hospitality business.

As your business grows, you may want to switch over to a perpetual inventory management system as it allows you to access the balance in your inventory account at any point in time.

Large businesses typically have perpetual inventory systems rather than periodic inventory systems due to the large volume of inventory transactions and the computerized nature of the rest of their financial and accounting systems.

A perpetual inventory system is also known as a continuous inventory system.  The premise of this type of inventory system is that is allows businesses to keep a real-time account of what inventory they have in stock.

• Learn more: Inventory Accounting – A Free Video Guide for Accountants & Advisors

How perpetual inventory works

The widespread use of automated and computerized systems makes this type of inventory tracking very achievable and beneficial to companies. Businesses are able to easily keep track of inventory as it sells. The perpetual inventory system uses tools such as barcodes, radio frequency identification (RFID) scanners, and point-of-sale (POS) systems to assist this type of inventory tracking as they rapidly record inventory information. When a customer purchases an item, the item is instantly scanned and therefore tracked.

This type of inventory system requires a complex infrastructure in order to facilitate the tracking mechanisms. Perpetual inventory is often used in large businesses whereas simpler systems like periodic inventory are generally seen in smaller businesses.  Perpetual inventory systems are also used when a company has more than one location or when a business carries expensive goods such as an electronics company or jewelry store.

It is important to note that errors in inventory are often due to loss, breakage, theft, incorrect inventory tracking or scanning problems.  These errors are disadvantages but need to be weighed against the many positives of a perpetual inventory system.

With a real-time system updating constantly, there are many advantages to the business owner. It is a proactive way to prevent stock from running out as when stock is low it can be instantly identified and stock can be reordered. It also gives business owners a better understanding of customer buying patterns and their purchasing behavior.  A more accurate understanding of customer preferences can guide which items a business stocks and when they place them on the sales floor.  If a company has several locations, a perpetual inventory system centralizes this management. It amalgamates all information and places it in one consolidated and accessible place. Overall, this automated system is more accurate and accurate information can be very valuable to a business owner. It can assess if customers were responsive to discounts, their purchasing habits, and if they returned any items. Unlike periodic inventory systems, the perpetual module reduces the need for frequent, physical inventory counts.

In order for perpetual inventory systems to work as accurately as possible, the quality of both the system and data needs to be high. Cloud-based inventory management software can be a powerful tool in executing a high quality inventory system. In order to best utilize the real-time data of a perpetual inventory system, an automated and advanced system will yield the most consistent results, reducing the risk for errors. If a business is small and anticipates growth, it is worth looking into switching to from a periodic system to a perpetual system.

With this real-time data it allows for companies to be more competitive. A perpetual inventory system can bring many advantages that allow for an in-depth understanding of consumer purchasing behavior.  This kind of information has the power to shape the way a company operates, encouraging performance at their optimum level.

Melanie

Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.

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Topics: cloud-based software, customer behaviour, multiple warehouses, perpetual inventory, serial number tracking

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