Periodic and perpetual inventory management systems are two effective methods to track inventory. Periodic inventory is often used in small businesses and can be an economical tracking system.
A periodic inventory system updates inventory at the end of a certain time period within a business. For example, inventory records could be updated monthly, quarterly, or annually. Periodic inventory is generally recorded alongside a reporting period, which is an allocated timeframe to collate all financial activities that happened during that specific time. Again, the reporting periods are usually quarterly or annually and match up with the periodic inventory.
Since a periodic inventory system only keeps track of inventory at certain times of the year, not as inventory is purchased or sold, it is necessary to manually count the inventory. Physical counting is necessary to get a full and exact count of every item in the current inventory. Depending on the size of inventory, the process of undergoing periodic inventory can be exceptionally time consuming and tedious. If a business has hundreds or thousands of different products, this increases the amount of time spent recording and also creates opportunity for mistakes. Physical counts are also subject to human error and incorrect counts can lead to problems.
Any inventory purchases made between the physical counts are put into a purchases account. This is used to record all inventory that the company buys and the price paid for each item. The purchases account starts with the beginning balance of inventory. This is a complete and exhaustive record of the all the items that the company has on hand that will be resold. During this recording period any additional purchases are logged onto this same ledger. These entries explicitly track inventory goods, meaning they will be resold. The entries will track the number of items purchased, how much they cost, the date and vendor.
Adding the inventory’s beginning balance, which is the amount of money spent on inventory items at the beginning of the period, to the total amount of money spent on any additional inventory purchases during the same recording period will give you the costs of goods for sale.
After the physical count has taken place, it will show how much inventory is in stock. A business can then calculate the ending balance, which shows how much the inventory is actually worth. For this reporting period, it is then necessary to subtract the ending balance, from the costs of goods for sale. The company can determine how much inventory was sold during this reporting period and for how much money. This final number is referred to as the cost of goods sold (COGS).
These formulas are an important part of a periodic inventory system:
Beginning Balance of Inventory + Cost of Inventory Purchases = Cost of Goods for Sale
Cost of Goods for Sale – Cost of Ending Inventory = Costs of Goods Sold (COGS)
The cost of the ending inventory can be determined with a last-in-first-out (LIFO) or first-in-first-out (FIFO) accounting model. When the next period begins, the beginning inventory is previous period’s ending inventory.
Periodic inventory systems are often adopted by small businesses. It is a very economical form of accounting and can be executed with a cash register and basic accounting methods. Additionally, if a company sells a service, a large inventory management system may not be necessary.
Other inventory management can be utilized as a business grows and the demand for inventory data evolves over time. Under a perpetual inventory system, all of a company’s inventory is updated in real time and is fully automated. It is important for a company to analyse their inventory demands and find the best system to meet their needs.
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.