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Guide to Perpetual Inventory Systems 2023

December 26, 2022 | Blog
Your business's lifeblood is inventory. Stock must be sufficient to meet customer demand. However, inventory should not exceed storage costs. An inventory system is an answer. A perpetual inventory system allows you to track inventory in real-time.   A perpetual inventory system automates inventory management. It's an automated inventory management system that can be used to manage your business.   Inventory management was probably one of your most difficult tasks before you opened your shop. Inventory management is not just about counting stock.   You probably know that inventory management includes many other processes, such as inventory control and costing. Depending on how it operates, some processes may not apply to your business.   It is essential to choose the right inventory management system for your business. This guide will help determine if the perpetual inventory system is right for your business.  

What Is Perpetual Inventory?

  Perpetual inventory can be described as a continuous accounting system that tracks inventory changes in real-time without the need to keep physical inventory. This ensures that the actual stock is accurately shown in the book inventory. Warehouses can register perpetual inventory with input devices like scanners and point-of-sale (POS) systems.   In warehouses and the retail sector, perpetual inventory is becoming more popular. Perpetual inventory can reduce overstatements (also known as phantom inventory) and understatements of inventory. For production, companies that use material requirement planning (MRP) must also have perpetual inventory.   Perpetual Inventory System  

What is a Perpetual Inventory System?

  The perpetual inventory method tracks inventory continuously, in contrast to the periodic system, which tracks inventory at each end of a specified accounting period (usually on a weekly, monthly, quarterly or annual basis).   The inventory levels are automatically updated, tracking the items purchased, received, and returned stock. The perpetual inventory method cannot be done without inventory management software or a point-of-sale system.   Businesses with larger inventory units or who don't have time to count items often use the perpetual inventory system manually. For example, grocery stores often use perpetual inventory accounting.   Different accounting methods track stock levels in periodic and perpetual inventory.  

Perpetual Inventory

  Modern retailers use a perpetual inventory method, which records inventory sales and purchases in real-time. A perpetual inventory system records the activity of products using computerized software such as a POS.   Businesses can see a complete breakdown of stock levels and changes when integrated with inventory management and order solutions.   As each transaction is complete, the perpetual inventory updates the cost of goods sold (COGS).   Businesses can therefore check their perpetual inventory system to see accurate stock levels.  

Periodic Inventory

  On the other hand, periodic inventory counts stock according to a schedule to measure levels of COGS. Employees record products purchased from suppliers in the company's purchasing account or ordering system.   Businesses cannot see their stock quantities or COGS before the end of their accounting period. This could be weeks, months, or quarters.   The periodic inventory method doesn't include real-time sales data, so they have to use manual calculations.   Beginning Inventory Value + Cost of Inventory Purchases Ending Inventory Value = COGS   Organizations with multiple product lines or large inventory volumes typically use the periodic inventory model. They don't have the resources to do regular counts and are therefore reliant on it. This method is time-saving but can lead to inaccuracies in inventory data.  

Perpetual vs. Periodic Inventory System

  Different types of businesses find periodic and perpetual inventory systems attractive because they offer unique benefits. The periodic inventory system is faster and allows companies to see real-time stock levels. However, perpetual inventory can be a time-consuming process.   There are, however, some key differences that you should be aware of.  

Purchase Account

  A purchase account can only be used in periodic inventory systems. The perpetual method debits the inventory accounts for each order. All product returns are later credited back to the inventory account.  

Cost of Goods Sold

  COGS in the periodic system is manually calculated at the end of the accounting period using inventory at the beginning and end. The automated system updates the COGS account for perpetual inventory with every sale and stock purchase uses an automated system.  

Sale Transactions

  The periodic system only requires one data entry at the end of each reporting period. This is when the COGS calculation is done. Perpetual inventory reports sales as they occur.  

Closing Entries

  Closing entries can only be used to update stock levels or COGS in periodic inventory systems.  

Tracking

  Because there is only one entry per reporting period, it is difficult for inventory and accounting records to be tracked.   Perpetual inventory systems keep detailed records of every purchase order and transaction. This gives businesses insight into their turnover rates. This allows companies to optimize their internal operations and warehouses to increase sales.  

Paper Trail

  The extensive paper trail perpetual inventory systems left behind improve a start-up or software development company's decision-making. To maintain healthy stock levels, stakeholders can refer to past reports.  

Inventory Management Cost

  Businesses can reduce labor and management costs by automating reporting using a perpetual inventory system. Companies should still conduct physical inventory checks to detect thefts, spoilage, and other discrepancies.  

Demand Forecasting

  Excel spreadsheets can be useful for taking quick snapshots of inventory quantities. Still, they don't provide a forecasting tool for future demand. Companies looking to improve their business intelligence may consider perpetual inventory systems.   The solution can integrate the POS with ordering software and forecasting solutions to use machine learning and algorithmic prediction of fluctuating demand. This allows organizations to optimize their procurement and reduce inventory costs.  

What are the Perpetual Inventory Costing Methods?

  Three costing methods are used to calculate the perpetual inventory method.  

First in, First Out (FIFO)

  This costing method assigns the Cost of Goods Sold to the oldest inventory units. This calculation assumes that the goods and raw materials are sold in the same order they were purchased.   Let's say you buy 100 units of product Z at $10, then you purchase 50 units at $20 a month later. Let's say that product X is a raw ingredient for product Z.   The cost of the 100 first units of product Z sold would equal the price of the 100 first units of ProductX. This is $10. The new price of product X would be $20 for the 50 additional units of Product Z.   FIFO is the end balance of inventory. This refers to the cost of purchasing raw materials. Companies assign a card to track and navigate through the amount, dollar amount, and quantity of goods in perpetual inventory systems. This card is called a Perpetual Stock Card. Each product has one. These cards can be updated in real-time with the dollar balance and quantity.  

Last In, first Out (LIFO)

  The LIFO method is an antonym for the FIFO method. It assigns the COGS to the most recent costs. It assumes that the most recent materials sales are the ones it uses.   Let's say you buy 100 units of product Z at $10, then you purchase 50 units at $20 a month later. Let's say that product X is a raw ingredient for product Z.   When a product is sold, the cost of the 50 first units of Z would equal the price of the 50 first units of Product X (i.e., $20). The new product purchase cost for Product X would be $10 for every 100 units sold.   LIFO allows for evaluating leftover inventory at lower prices while approximating the higher costs of new sales. When there is a significant difference between the current and previous prices, a "LIFO Layer" will be formed.   LIFO also tracks costs on a Perpetual accounting card so that goods and costs are regularly updated.  

Moving Averages (MA)

  This accounting method estimates the inventory's total inventory and its total cost, regardless of differing sourcing costs. The total inventory average is calculated. This average cost is used in the inventory system as COGS.   For example, let's say you bought 100 units of product Z at $10 and then purchased 50 units at $20 a month later. Let's say product X is a raw ingredient for product Z.   The inventory average cost is (100x10) + (20x50 100+50), = 2000/150 = $13.33/Unit.   The moving average is more balanced than LIFO and FIFO.  

Advantages of a Perpetual Inventory System

  A perpetual inventory system has many benefits specially for custom software development companies as it makes the process more efficient. These advantages are described below.  

Avoid Ongoing Physical Inventory Counts

  A perpetual inventory system eliminates the need to conduct regular inventory counts. This is a huge advantage, as any physical count will require a business's warehousing operations to be shut down. This also means outside auditors don't have to observe an inventory count.   Instead, they receive an inventory report with inventory locations and unit numbers, which they can compare against the actual inventory.  

Trustworthy Inventory Record

  A perpetual system records all inventory transactions in real time, so the inventory records can be trusted to be accurate. This is especially true when an ongoing cycle counting program complements it. Inventory reordering can easily be done with confidence when there is high record accuracy. It also means that businesses can offer customers reliable delivery dates, which may increase customer satisfaction and even increase sales.  

Detailed Paper Trail

  An inventory system that is perpetual keeps track of every inventory transaction. This allows for easier tracking errors in record keeping anywhere within the company. This is a great control. It also allows for transaction investigations to improve procedures and train, increasing inventory records' accuracy over time.  

Lower Inventory Investment

  A perpetual system can improve the accuracy of inventory records. This allows the material management staff to rely on the on-hand balance information. A business doesn't have to buy excess inventory. This is because they don't have to trust the inventory numbers and want excess inventory. This allows for lower inventory investment and can reduce inventory levels.  

Integration with Other Systems

  The record accuracy it provides to other systems is a key advantage of a perpetual inventory system. Customer service can inform customers how many units are on hand for shipment. The materials management team can also use the inventory records to determine how many units will need to be manufactured or ordered from suppliers. The accounting department can also use the inventory records to calculate the month-end inventory balance.  

Disadvantages of Using a Perpetual Inventory System

  There is no perfect inventory management system. These are just a few of the areas where perpetual inventory can fail.  

High-Priced Setups

  Although it is technically not a disadvantage to investing in an inventory management system, it can mean higher upfront costs than other options. This method requires the purchase of barcode scanners.   You will also need to invest in employee training for any new software or devices.  

Broken and Stolen items are Not Automatically Accounted

  The perpetual inventory method tracks all products sold, returned, or discounted. However, any actions outside the scope of the inventory management software, such as broken, spoiled, or stolen items, will not be recorded unless someone notices them or until an actual inventory count is done.  

Can Be Subject to Human Errors

  No inventory management system is perfect. Even though the perpetual inventory system is automated, it doesn't guarantee that it will be error-free.   It is easy for employees to make mistakes in entering inventory quantities, scanning products at the checkout, or handling returns.  

How does the Perpetual Inventory System Work?

  The perpetual inventory system updates inventory counts as goods are purchased and sold. This inventory accounting method is more efficient and accurate than a periodic system. This is a step-by-step overview of how this type of inventory system works.  

Point-of-Sale System Updates Inventory Levels

  The POS (point of sale) system's inventory management system instantly applies the debit to all main inventory channels. RFID (radio frequency identification) scanners or barcodes make this process quick and simple.   Let's take, for example, a company that sells scented candles. The customer buys 3 vanilla-scented candles, 3 units of one SKU, for $10.00 each, or $30.00 in total.   Each candle is scanned by a warehouse picker when he picks it up. Your perpetual inventory software reduces your inventory count by 3 when each barcode has been scanned.   Sales to customers trigger two accounting journal entries in your income statement and two on the balance sheet through the perpetual inventory system.   The amount the customer paid for the item, in this instance $30.00, is recorded on your income statement as a credit towards revenue. This same amount is recorded on your balance sheet as a debit or cash to accounts receivable.  

Cost of Goods Sold is Automatically Updated

  The cost of goods sold (COGS) is recalculated every time a product gets sold or received. Assuming the same scenario, the COGS per vanilla-scented candle is $5.00 (which includes overhead expenses such as raw materials, warehouse labor, and overhead expenses). Each time a candle has been scanned, an additional $5.00 is added to your overall COGS. This means that the COGS for your business increased by $15.00 after scanning 3 candles.   Two additional accounting journal entries should record $15.00. Your income statement records $15.00 as a debit to COGS. This same amount is also credited to inventory on your balance sheet.  

Reorder Points Are Adjusted Frequently

  A perpetual inventory system, based on historical data, will automatically update reorder points as sales increase or decrease to maintain an optimal inventory level at all times.   Let's assume that your store sells a holiday-themed candle and that sales have risen every quarter for the last four years.   The sales data from the last 4 years will create a perpetual inventory system that automatically increases your reorder threshold by 25 units to 50 units. This allows you to reorder stock faster than normal and prevents stockouts.  

Purchase Orders Are Automatically Generated

  The system automatically generates a new purchase request for each item or SKU that reaches its reorder point. It then sends it to your supplier without any human intervention.   As you expected, holiday-themed candle sales will increase in Q4. Your perpetual inventory system will generate an automatic purchase order for 500 additional candles, which can be purchased at $3.00 per piece.   Another journal entry is created when you make a purchase. This time, it will only be on your balance sheet. In this case, $1,500 should be recorded as a debit against inventory and credited to accounts payable or cash.  

Received Products Are Scanned into Inventory

  Warehouse employees scan inventory when it is shipped to their warehouse. This allows them to display the product in your inventory management dashboard.   Let's assume that the purchase order is accepted and that your supplier ships 500 candles within a week.   Each unit is scanned using a barcode scanner, and warehouse workers check the quality before moving to storage. The perpetual inventory system automatically raises the inventory count for each SKU once a unit has been scanned. After scanning all 500 units, the inventory count should be increased by 500.  

Things to Consider Before Choosing an Inventory System

When deciding between a periodic and perpetual inventory system, there are many things to consider.  

Stock Size

  The inventory size determines the number of employees and resources required to manage the products properly.   It may be simple for startups to count their items manually using the periodic system. However, this may not be feasible for larger companies. Businesses looking to expand should plan for the future and forecast their long-term inventory requirements.  

Business Sites

  Organizations with multiple locations also require software that integrates inventory data from all locations and each sales channel.   Managers could overstock, resulting in unnecessary holding costs. Companies can find products in the supply chain by simply clicking a button with management solutions.  

Transaction Volume

  Depending on their stage in life, every company will have different transaction levels. Startups may still build a customer base but established businesses might experience high transaction volumes.   An inventory system is essential for organizations that have more transactions per day. It should be able to update quantities frequently with each purchase and sale.  

Budget Restrictions

  Perpetual inventory systems are expensive and require an initial investment. Automation eliminates the need to have human intervention. This reduces labor costs over the long term.   On the other hand, periodic inventory systems require manual counts but only once per accounting period. Managers must evaluate their budgets and manage their needs to decide which option is best for them.  

Top Notch Features of Inventory Software

Many inventory management and order systems are available, but business owners need to look for the best.  

Tagging and Barcoding

  Barcoding, tagging, and other automation tools reduce the chance of human error in manual data entry. Businesses can reduce the time it takes to train employees, count cycles, and place reorders by incorporating barcodes in their inventory management processes.  

Inventory Tracking

  Advanced inventory systems allow employees to find stock by exchanging data between locations. Businesses can then transfer products between their locations before they submit purchase orders. This reduces inventory costs.  

Reporting tools

  Many inventory management systems provide reporting tools that allow you to analyze specific product elements.  
  • Turnover rates
  • Profit margins
  • Localization
  • Product variances
  • Prices
  Reporting tools enable data-driven decision-making so that companies can make informed, fast decisions.  

Forecasting

  Businesses may overstock products due to poor inventory utilization and demand trends. This can lead to lost sales, increased holding costs, or reduced profitability. Customers can be frustrated by stockouts and may switch to more readily available products.   To determine future requirements, companies must ensure that inventory management software tracks sales trends for each product line.  

Automated Notifications

  Before modern inventory software, employees were required to keep track of stock data to replenish shrinking inventory. Advanced automated systems send alerts when products fall below healthy levels and trigger a reorder. Alerts can be programmed by businesses for-  
  • Anomalies
  • Shipments incoming
  • Supplier notes
  • Delayed deliveries
  • Up-to-date
  This allows companies to address problems quickly and efficiently.  

Integration Capabilities

  Businesses that want to increase their intelligence must integrate. Integration capabilities in inventory software allow you to connect with other management systems, such as-  
  • Point-of-sale
  • Forecasting the demand
  • Scheduling
  • Management of employees
  Companies can integrate all software to generate detailed reports and provide actionable insights to optimize their internal processes.  

Security

  Companies dealing with sensitive customer data, financial, and inventory information should prioritize data security. Owners must ensure that their inventory solution has protection measures and firewalls to protect incoming and outgoing information.  

When One Should use a Perpetual Inventory System?

  Businesses need a perpetual inventory system to operate in a dynamic environment. This means that the warehouse or inventory space is not closed for physical counting and checking of goods. The perpetual inventory system performs multiple inventory functions, including COGS and goods/items. All transactions are updated automatically without the need to be checked constantly.   This makes it crucial to control the number of goods shipped in and out. Large companies with many materials to manage over short periods need inventory control. To estimate demand and supply, large organizations require inventory control. They can do this by using perpetual inventory methods.   Technology investments are also required for perpetual inventory systems. This includes a robust database that can handle real-time data recording and security and inventory side devices such as barcode scanners and POS machines.  

The Perpetual Inventory System: Key Takeaways

Perpetual Inventory Accounting has some key takeaways.  
  • Large-scale companies with a high volume of specialized inventory goods (e.g., Jewellery, Metals, etc.) use it.
  • Although it is costly, inventory control and financial benefits are tenfold.
  • It is important for demand forecasting and supply forecasting.
  • With perpetual inventory management systems, it is much easier to identify trends and draw data in inventory control than periodic inventory management.
  • Perpetual inventory systems do not record thefts and leakages, so the stock physical examination must be performed only once per year. To correct inventory measures, it is necessary to make any data changes.
  • The Perpetual Inventory system provides accurate financial metrics.
  • Employees must receive training to make it easier to use the computer.
  • Moving Average (MA), the best method to track inventory in perpetual accounting with FIFO or LIFO being difficult to implement is more effective than FIFO and LIFO.
 

Conclusion

  Although the benefits of perpetual accounting are extraordinary, they also come with a high price. These systems are the backbone of large-scale inventory systems.   Perpetual inventory systems are gaining popularity as they provide forecasting tools that can be used to predict future events. Perpetual inventory systems will be used more widely by major software development companies and e-commerce companies like Amazon as they look to reduce excess inventory bulk.
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