A periodic inventory system is a method of keeping track of inventory where inventory counts are only updated periodically. The alternative to this is a perpetual inventory system where inventory counts are automatically updated whenever stock is received, moved or sold. There are pros and cons to both systems and really it is the responsibility of the business owner to research the two and make an informed decision as to which would be best for the individual company. Here we will take a closer look at periodic inventory systems.
How the periodic system works
The periodic inventory system is very easy to set up and only really requires a way of recording inventory (ledger or spreadsheet), time and labor to count. Essentially it relies on periodic stocktaking of inventory and recording at this point, rather than after every change in inventory (due to a purchase or sale for example). Usually, stock is counted annually, though it can be at any interim the company decides upon.
As with any inventory system, the purpose is to have an idea of the amount spent on inventory, the amount of inventory remaining and the true cost of goods sold.
With the periodic inventory system, it is difficult to gain an accurate understanding at any given point about the health of the company’s inventory and the cost of the goods sold. This is because the inventory balance or count is carried over from the final count at the end of the preceding period. And then any purchases or sales of inventory in the current period are only recorded to the balance sheet so it is only at the end of the current period when the true cost of goods sold is calculated based on the beginning and final inventory counts. The following formula is used to calculate the cost of goods sold:
Beginning inventory + Purchases – Final inventory = Cost of Goods Sold (COGS)
Pros of the periodic inventory system
If the company is small and does not have a huge amount of disposable income, then the periodic inventory system could be the method of choice. It is cheap to set up, requiring only a way of recording data, time and labor to conduct an accurate stock count.
A positive by-product of the semi-regular physical stock count in a periodic system is that stock is physically viewed, counted and reorganized. This provides a fantastic opportunity to physically clear out clutter and reorganize the warehouse into a sensible configuration that promotes accurate storing and moving of goods.
Cons of the periodic inventory system
There are a few cons of the periodic system to consider. If an accurate inventory count and value is required in the middle of the period, a physical and time consuming count will need to be conducted. This is because there is no way of keeping up-to-date data on purchases and sales of inventory (this is recorded to the balance sheet).
The periodic physical stock counts that are conducted can also be very time consuming and can result in staff needing to work nights or weekends if it is conducted out of hours. This may not be positive for staff morale, in which case it can be conducted in work hours, however would require business to be stalled for the duration of the count. This may be the better option, however it will result in a loss of revenue (particularly for a retailer) for the duration of the count.
The periodic system can also result in more hassles than it is worth for relatively large companies or companies with a vast array of products or services. Therefore, the periodic system does not add much in the way of future proofing.
Are there alternative options?
The perpetual inventory system could be a method worth considering if the company is sizeable or you would like to reduce the amount of staff time spent counting and keeping track of inventory. The perpetual system is where inventory is constantly updated to include current purchases and sales of goods, which then allow for a current cost of goods sold. This is achieved through automated counting and tracking of inventory through the use of barcodes, serial numbers and integrated software. Unleashed Software is a great product to help with this and can be available at a very reasonable cost if that is a consideration for a small business. This system is beneficial due to its ability to produce up-to-date inventory data allowing for informed decision making regarding sales and purchasing.