Of the two predominant inventory systems available to businesses – periodic inventory and perpetual inventory– it is the latter which offers the greatest number of benefits. For any business looking to exercise complete control and efficiency of its inventory system, a perpetual inventory system is an absolute necessity.
Before gaining an insight into how a perpetual inventory management system works to help process managers optimise their inventory, cut down on costs, free up working capital and boost profitability, it is important to understand just what a perpetual inventory system is and how it functions.
What is a perpetual inventory system?
A perpetual inventory system is best understood as an inventory system that records and updates the inventory records of a business after each transaction. This includes any addition to or subtraction from its stock.
Most typically, perpetual inventory is thought to involve point of sale transactions only – i.e., the use of ECRs (electronic cash machines) and barcode scanners to record the sale of an item, and then update the inventory records as well as accounting records to reflect the change in inventory levels, as well as the cost of goods sold, gross and net profit margins.
A comprehensive perpetual inventory management system however, will record and account for any item of inventory that is bought, stored, moved from location to location, picked for use in production, or sold at point of sale.
The most notable aspect of perpetual inventory is that it triggers a ‘supply chain reaction’ from point of sale, down through the rest of the supply chain and accounting processes. As soon as an item is sold at point of sale, the inventory management software automatically updates the inventory and accounting records to accurately reflect inventory levels in the warehouse and on the balance sheet in real-time.
This enables a business to rely on up-to-date, accurate and relevant information regarding the status of its inventory, which is not the case for the other type of inventory system – the periodic inventory system.
What is a periodic inventory system?
Periodic inventory systems require inventory to be physically counted at the end of a designated period or sales cycle – such as end of season, end of year, quarterly, or even monthly.
Periodic inventory management relies solely on manual stocktaking to balance its inventory records with what is actually on stock. This system requires that the accounting department calculate inventory levels by subtracting their year-end or period-end inventory stock count from the year-beginning or period-beginning inventory total.
There are various accounting formulas used to carry out these calculations, such as FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) – each of which will give a different inventory value on the balance sheet, and impact the net profitability of the company in different ways. Each accounting method offers its own particular set of advantages and disadvantages to the business, and should be considered carefully.
It is important to note that by using the periodic inventory method, a business will only be able to know its inventory levels with accuracy at the beginning and end of each period. The time spent operating between stocktakes will leave process managers somewhat in the dark as to the state of their inventory.
The ability to track, trace, and account for inventory with the degree of accuracy required to forecast, purchase, and plan efficiently can be significantly hampered by reliance upon a periodic inventory system.
That being said, for businesses overseeing a small inventory or for strictly service-oriented businesses, a periodic inventory system can be sufficient.
Advantages of perpetual inventory
Perpetual inventory systems afford companies three key advantages. The first has been touched on above – real-time, accurate, and integrated inventory data across the supply chain that is updated with each transaction.
Inventory level automation
Process managers are able to effectively have their finger on the pulse of the supply chain and automate re-supply requirements. Re-order and high inventory points can be set and automated to ensure that once inventory approaches low or high levels, re-orders can be made in time or purchasing can be restrained. This ensures that the business does not suffer from losses as a result of over stock or under stock.
Better demand forecasting
While no one can forecast surges in customer demand with 100% accuracy, having access to reliable and up-to-date inventory data considerably improves the demand forecaster’s performance.
Better forecasting drives smarter purchasing, as well as sales and marketing decisions – which in turn drive the costs associated with inventory down, and profits as a result of hitting higher customer service targets up.
Accurate financial reporting – knowing the numbers
Perpetual inventory management systems help to ensure that the company’s financial statements are accurate. A business that does not know, or have access to, its most valuable information – its numbers – cannot expect to perform well. Vital figures such as the COGS (Cost of Goods Sold) can be recorded and relied upon with confidence when a perpetual inventory system is utilised.
Accurate financial records enable the business to know how profitable it really is. If the COGS are inaccurately reported in the financial statements due to poor implementation of inventory controls, then the discrepancy between the actual cost of goods sold and what is reported might vary. A business that operates from flawed financial reporting can very quickly begin to experience losses.
Knowing the numbers of the business is also critical to ensure that areas of opportunity can be capitalised on and areas of loss can be shut down. When a process manager is able to identify which inventory is costing too much, moving too slowly or simply being rendered obsolete, he can put countermeasures in place. Likewise, clear trends for in-demand, fast-moving inventory can be identified and resources – working capital, marketing and sales – can be better directed towards the stock that actually makes the business the most money.
Bye-bye barriers to entry – powerful inventory management for all
For businesses looking to optimise profitability through effective inventory management, investing in an inventory management software solution that perpetually tracks, traces and accounts for inventory in real-time, is undoubtedly the way to go.
As barriers to entry – high costs, sophisticated and hard to use technology, regular maintenance issues and upgrades – become irrelevant as cloud based SaaS (Software-as-a-Service) solutions become increasingly affordable and easy to implement, even small businesses can enjoy the benefits that a state-of-the-art inventory management system affords.
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.