Perpetual Inventory | 8 mins read

Guide to Establishing a Perpetual Inventory Management System

guide to establishing a perpetual inventory management system
Chloe Henderson

By Chloe Henderson

Businesses that offer goods and services handle large volumes of inventory data from both the front and back-end.

In-store, employees use a point-of-sale (POS) system to record customer purchases and track outgoing products. Behind the scenes, warehouse managers navigate inventory management and ordering solutions to maintain healthy stock levels and ensure they can meet customer demand.

However, consolidating this information is difficult without adequate inventory accounting methods. With perpetual inventory, all stock information is collected and consolidated from established management systems so that managers can access real-time data. This high level of visibility enables companies to improve their strategies and optimize internal systems.

What is Perpetual and Periodic Inventory?

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Perpetual and periodic inventory use different accounting methods to track available stock levels-

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Perpetual Inventory

Most modern retailers use a perpetual inventory system, as it immediately records the sale or purchase of inventory in real-time. The perpetual inventory method records products' activity through computerized software, such as a POS system.

When integrated with inventory management and ordering solutions, businesses can view a full breakdown of stock changes and levels.

Perpetual inventory also updates the cost of goods sold (COGS) as each transaction is completed.
Therefore, businesses can check their perpetual inventory system at any point to view accurate, real-time stock levels, assuming there is no theft or discrepancies.

Periodic Inventory

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On the other hand, periodic inventory physically counts stock on a set schedule to measure levels and COGS. When products are purchased from a supplier, employees record the order in the company's purchase account or ordering system.

This means that businesses cannot see their actual stock quantities or COGS until the end of their accounting period, which could be weeks, months, or quarters.

Since the periodic inventory method does not incorporate real-time sales data to measure the COGS, they must use manual calculations-

Beginning Inventory Value + Cost of Inventory Purchases Ending Inventory Value = COGS

The periodic inventory model is typically used by organizations with several similar product lines or high inventory volumes and does not have the means to conduct regular counts. While this method saves time, businesses tend to experience inaccuracies in their inventory data.

Perpetual vs. Periodic Inventory System

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The perpetual and periodic inventory systems appeal to different types of businesses, as they provide unique benefits. While perpetual inventory enables companies to view real-time stock levels, the periodic method is less time-consuming.

However, there are several other key differences to note-

  • Purchase Account
A purchase account is only used in a periodic inventory system, as the perpetual method debits the inventory account for every order. Any product returns are later credited to the inventory account.

  • Cost of Goods Sold
In the periodic system, COGS is manually calculated at the end of the accounting period by comparing inventory at the beginning and end of the cycle. Perpetual inventory utilizes automated systems to update the COGS account with each sale and stock purchase.

  • Sale Transactions
Under the periodic system, only one data entry is made at the end of the reporting period when the COGS is calculated. With perpetual inventory, sales are reported as they occur.

  • Closing Entries
Closing entries are only applicable to periodic inventory systems to update stock levels and COGS.

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  • Tracking
The periodic system makes it difficult to track inventory and accounting records, as there is only one entry each reporting period.

Perpetual inventory systems log detailed entries for every purchase order and transaction, giving businesses insight into turnover rates. This enables companies to optimize their functions, internal operations, and warehouses to boost sales.

  • Paper Trail
The extensive paper trail that perpetual inventory systems leave behind improves the company's decision-making. Stakeholders are able to reference past reports to enhance their ordering strategies to maintain healthy stock levels.

  • Inventory Management Cost
By automating reporting with a perpetual inventory system, businesses experience reduced labor and management costs. However, companies should still maintain physical inventory checks to detect theft, spoilage, and other discrepancies.

  • Demand Forecasting
While spreadsheets are great for quick snapshots of inventory quantities, they are not very useful for forecasting future demand. Therefore, companies looking to expand their business intelligence should consider perpetual inventory systems.

By integrating the POS and ordering software with forecasting solutions, the solution can use machine learning and algorithms to predict fluctuating demand. This enables organizations to optimize procurement to boost sales and minimize inventory costs.

How Does a Perpetual Inventory System Work?

The perpetual inventory model continuously updates counts as products are bought and sold, improving data accuracy and efficiency. Typically, perpetual inventory systems follow five basic steps-

1. Implement a Point-of-Sale System

A POS solution records transactions from all sales channels as they occur and sends the information to the integrated inventory management system. This is often seen in grocery stores when cashiers scan the barcodes and the computer instantly recognizes the product.

2. Update the Cost of Goods Sold

Similarly, inventory software uses procurement invoices and transactions to update their COGS calculations, improving financial reporting.

3. Adjust Reorder Points

As customer demand fluctuates, the POS system exchanges transactional data with inventory management and ordering solutions so they can improve reorder points. By maintaining optimal stock levels, businesses can avoid over or underordering products, which can restrict profits.

4. Generate Purchase Orders

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By integrating all management solutions, low inventory levels can automatically trigger reorder points, generating a new purchase order. This way, employees can review and approve the request, which is then sent to the supplier.

With automation, businesses can reduce human error and the resources needed to regulate stock levels. It also ensures that companies can prevent stockouts and backorders.

5. Integrate Received Products

Once inventory shipments reach the warehouse, an employee must scan the packages to enter units into the management software. This integrates the quantities into all sales channels, so customers can begin purchasing the products.

However, workers must first cross-examine the shipment list, purchase order, invoice, and physical units to ensure all items are present and intact. Otherwise, companies can experience inventory discrepancies from incorrect shipments or damaged goods.

Things to Consider Before Choosing an Inventory System

There are many factors to consider when choosing between a perpetual and periodic inventory system, including-

Inventory Size

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The number of employees and amount of resources needed to adequately manage products entirely depends on the size of the inventory.

While it may be easy for startups to manually count their items using the periodic system, it may not be reasonable for larger companies. Businesses actively working towards expansion should also plan for the future and forecast their long-term inventory needs.

Business Sites

Similarly, organizations with multiple locations need software that can integrate inventory data from each site and sales channel.

Otherwise, managers could easily overstock items, creating unnecessary holding expenses. With management solutions, companies can locate products throughout the supply chain with the click of a button.

Transaction Volume

Every company has different transaction levels depending on where they're at in the lifecycle. While startups may still be creating a loyal customer base, established businesses may experience consistently high transaction volumes.

Organizations with more daily transactions need an inventory system that frequently updates quantities with every purchase and sale.

Budget Restrictions

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While perpetual inventory systems require an initial investment, automation eliminates the need for human intervention, reducing labor costs in the long run.

On the other hand, periodic inventory systems require manual counts, but only once an accounting period. Therefore, managers must assess their budget and management needs to determine which option is most cost-efficient for their operations.

Benefits of a Perpetual Inventory System

There are numerous advantages that perpetual inventory systems provide businesses, including-

Access to Real-Time Data

With continuous updates, perpetual systems offer access to real-time inventory reports that changes with every transaction, significantly improving data accuracy.

Creating a Paper Trail

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By tracking all inventory movements throughout the supply chain, companies create an extensive paper trail. This is helpful for improving supply chain management, pinpointing bottlenecks, and optimizing stock orders.

Decreased Management Costs

By maintaining low stock levels, businesses can minimize their order, carrying, and storage costs. Integrating systems will also automate reorders so that warehouses can save labor costs.

Automated Calculations

While some businesses still use manual methods to calculate end-of-year balances, perpetual inventory systems continuously update financial records. This saves the time and labor required to consolidate a year's worth of stock data, which can introduce human error.

Improved Demand Forecasting

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Companies are unable to accurately forecast future demands with periodic inventory systems, as they do not show sales trends.

On the other hand, perpetual inventory solutions provide the analysis required to predict future demand. With accurate demand forecasting, businesses can optimize their inventory levels to capitalize on the newest trends.

Uncovered Discrepancies

By combining the perpetual inventory method with occasional physical stock counts, companies can quickly detect and resolve discrepancies. With detailed entries, managers can investigate internal theft, shrinkage, and repetitive counting errors.

Helpful Features of Inventory Software

While there are numerous inventory management and ordering systems on the market, business owners should look for solutions with-

Barcoding and Tagging

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Barcoding, tagging, and other automation tools eliminate the risk of human error included in manual data entries. By implementing barcodes into inventory management procedures, businesses can minimize the time required for employee training, cycle counts, and reorders.

Inventory Tracking

Advanced inventory systems can exchange data from each location, enabling employees to locate stock. This way, businesses can transfer products between their sites before submitting purchase orders, reducing inventory costs.

Reporting Tools

Most inventory management systems offer reporting tools that generate a detailed analysis of specific product elements, such as-

  • Turnover rates
  • Profit margins
  • Location
  • Product variances
  • Costs

Reporting tools support data-driven decision-making so companies can make educated, quick choices.

Forecasting

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With poor insight into inventory usage and demand trends, businesses may under or overstock products resulting in either lost sales or increased holding costs, limiting profitability. Stockouts can also frustrate customers, sending them to competitors with available products.

Therefore, companies should ensure that their inventory management software can track sales trends for each product line to determine future needs.

Automated Alerts

Before modern inventory software, employees had to monitor stock data to replenish diminishing inventory. Now, advanced automated systems send alerts whenever products dip below healthy levels, triggering a reorder. Businesses can also program alerts for-

  • Anomalies
  • Incoming shipments
  • Supplier notes
  • Delayed deliveries
  • Updates

This ensures companies can address issues as they arise for speedy resolution.

Integration Capabilities

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Integration is a must for businesses looking to expand their intelligence. Inventory software with integration capabilities can connect with other management systems, including-

  • Point-of-sale
  • Demand forecasting
  • Scheduling
  • Employee management

By integrating all software, companies can generate more detailed reports and actionable insights to optimize internal processes.

Security

Data security should always remain a top priority for companies that handle sensitive financial, inventory, and customer information. Therefore, owners must ensure that their inventory solution has firewalls and protective measures to keep incoming and outgoing data secure.

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