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- Perpetual vs Periodic Inventory Systems: Overview
- Periodic Inventory Systems
- Perpetual Inventory Systems
- Key Differences Between Perpetual and Periodic Inventory Systems
- How Community Tax can Help With Your Accounting Services
- Takeaways on Perpetual vs Periodic Inventory Systems
Perpetual vs Periodic Inventory Systems: Overview
Perpetual vs periodic inventory systems are the two inventory tracking systems used by small business and large business owners alike. Both work by keeping you up to date on the status of your business’s merchandise, items, materials, and other assets. However, the main difference between perpetual vs periodic inventory systems is when inventory is accounted for.
Perpetual inventory systems track inventory as you go. So, with every transaction, whether a purchase or return, a perpetual inventory system will record it. This means you’ll always stay up to date with what you have in stock and which items may be running low.
On the other hand, a periodic inventory system updates your inventory records on a periodic basis at the end of an operating cycle, whether weekly, monthly, quarterly, or annually. This system requires a physical count of inventory to determine the cost of goods sold and ending inventory.
Keeping an accurate track of inventory is important for all businesses, as it is an essential step when you create a budget and maintain proper accounting records. Below, we’ll go over both perpetual and periodic inventory systems in depth, so you can determine which one best suits your business needs.
Periodic Inventory Systems
Of the two inventory systems, the periodic inventory system is the simpler one. As previously stated, the periodic inventory system does not keep track of a company’s inventory on a daily basis. Instead, a periodic inventory system tracks inventory at the end of an accounting period, whether it’s weekly, monthly, quarterly, or annually. A business using a periodic inventory system must count inventory by hand, which requires companies to close their shop for a set period of time to take count, or set aside hours after work to take count. This process can be time-consuming, especially if a company has a lot of inventory to count. With a periodic inventory system, a company must determine the cost of goods sold (COGS). To calculate the COGS, a business must follow this formula: Cost of Goods Sold = Beginning Inventory + Inventory Purchases – Ending Inventory For example, let’s say a small natural foods store begins the quarter with $350,000 of inventory. During the three months of the quarter, the natural foods store buys an additional $100,000 of inventory. At the end of the quarter, the employees do a physical count of the store’s inventory and find there’s an ending inventory of $275,000. That means the COGS for the first quarter is $175,000 (350,000 + 100,000 – 275,000). The downside of a periodic inventory system is that it does not give a fully accurate depiction of the COGS because it is only calculated at the end of the accounting period. During the accounting period, whether weekly, monthly, quarterly, or annually, the business will not have inventory counts in real-time. This makes it difficult to forecast and determine when products need to be reordered and find discrepancies such as lost, stolen, or damaged items. At the end of an accounting period, a company will need to make adjustments to their account entries in order for its inventory and cost of goods sold to match. However, the periodic inventory system is suitable for a variety of businesses and scenarios. Some examples include:- New small businesses that can’t afford a perpetual inventory system
- An art gallery that only sells a limited amount of paintings or artwork a year
- A furniture or mattress store with limited inventory
- Car dealerships with a small inventory to keep track of
- Jewelry stores and other stores with limited, but high-value items
Perpetual Inventory Systems
When it comes to small business accounting, perpetual inventory systems may be the smarter choice in many cases. A perpetual inventory system keeps track of a company’s inventory daily after every transaction is made. This allows businesses to know how much inventory is in stock, along with the cost of goods sold at any given moment. Without having to wait until the end of an accounting period to see how much inventory is left, a business will be able to maintain accurate records. With accurate records, a business will be able to decide when to order inventory in order to prevent stockouts (when items are no longer available), and overstocking (when too many items are ordered). However, both stockouts and overstocking present their own problems. For example, running out of inventory can cause you to lose sales if customers are looking for that specific item. Conversely, you can lose money from overstocking due to the cost of holding items. Let’s say you own a grocery store and overstock on perishable items like fruits and vegetables. You can lose a substantial amount of money on inventory that has gone to waste if you overstock. With a perpetual inventory system, you’ll be able to keep track of all of your inventory to maintain a healthy balance. This is done by utilizing computerized software and a point-of-sale system that tracks every transaction, such as purchases and returns. This will give you more time to conduct business, rather than having to close up shop or work after hours to count inventory. However, perpetual inventory systems do require at least one physical count of inventory a year to compare physical inventory to the inventory tracked in the software.
For both periodic and perpetual inventory systems, it’s worth investing in a loss prevention system to combat theft and burglary. Your inventory can be seriously impacted from items being stolen, especially if they’re big ticket items. So, security cameras, burglar alarms, and other measures can help ensure your valuable assets are protected and secure.
Key Differences Between Perpetual and Periodic Inventory Systems
Now that you know what perpetual inventory systems and periodic inventory systems are, it’s time to understand the key differences between the two. Both come with their own pros and cons, which are important to consider when choosing one for your business. Here are the differences between perpetual vs periodic inventory systems, including their pros and cons:
Periodic Inventory Systems:
- Pro: Periodically tracks inventory balances either weekly, monthly, quarterly, or annually
- Pro: One journal entry is made when there’s a sale transaction
- Pro: Does not require inventory software
- Pro: Typically used by businesses with few inventory units, such as art galleries and jewelers
- Pro: Cheaper and requires less work
- Con: Difficult to identify errors and discrepancies, such as loss, theft, and damage
- Con: Unaware of inventory quantity until the accounting period ends
- Con: Requires a closing entry
- Con: Difficult to forecast and reorder items
- Con: Provides little control over inventory
- Pro: Keeps continuous track of all inventory balances with every sale or transaction
- Pro: Two journal entries are made when there’s a sale transaction
- Pro: Does not require a closing entry
- Pro: Can easily forecast and reorder items
- Pro: Typically used by businesses with a lot of inventory units, like grocery stores or office suppliers.
- Pro: Provides control over inventory due to up-to-date tracking
- Pro: Easier to identify errors such as loss, theft, and damage
- Con:Technology is expensive and requires trained personnel
- Con: Requires a physical count of inventory once a year
- Con: Requires inventory software
