Businesses, especially ones that carry thousands of products in multiple storage locations, will need to devote time and resources to inventory accounting, no matter which method they choose. Choosing between periodic and perpetual inventory accounting is crucial to keeping inventory records that work with your workflow instead of against it.
For these methods, the difference is how and when inventory is accounted. For businesses of varying sizes and goals, this difference represents a loss or gain of control over their supply chain workflows. Strategically accounting for inventory requires knowing how each type will affect workflows of different sizes in the current market.
What is periodic inventory accounting?
Period inventory accounting takes inventory at scheduled times, including merchandise inventory and cost of sales. The cost of goods sold (COGS) is not updated at all until a manual count is done, which can then be used to calculate it.
With periodic inventory, businesses utilize a simpler method for accounting for inventory, which may appeal to smaller businesses. This strategy can utilize manual accounting methods such as traditional purchases accounts. This data is moved to the inventory account at the end of the accounting period so the new balance can be applied to the next period.
What are the benefits and downsides of periodic inventory?
Periodic inventory is a simpler accounting process. For small businesses with inventories that are easy to physically manage, periodic inventory requires less technological infrastructure, so it’s much cheaper. It also leaves less room for costly inventory shrinkage and damage due to requiring frequent manual counts.
Essentially, this is how inventory has always been taken. However, basing end-of-period inventory on manual counts has its downsides, not the least of which is the higher possibility for human error in increasingly competitive industries.
Another downside to periodic inventory is its inability to calculate complex inventory control figures. For example, cycle counting is impossible since purchases accounts don’t keep individual unit-count records. COGS is not updated in real-time either. Additionally, inventory-related errors in accounting records are extremely difficult to track, leading to losses that cannot be recovered.
In short, only businesses with inventories that can be manually managed should consider periodic inventory now, in the age of advanced inventory management software. Yet, for those businesses, the simpler method could be a cost-effective one.
What is perpetual inventory?
The perpetual inventory method updates the inventory balance continually. Unlike periodic inventory, perpetual inventory is not viable without a robust POS and inventory management system to record purchases and track inventory in real time.
This system is more detailed and modern, tracking accurate counts for merchandise inventory, COGS, cycle counts, raw material records, and more without waiting for accounting periods to begin or end.
What are the benefits and downsides of perpetual inventory?
The benefits of keeping perpetual inventory relate to its real-time updates of inventory-related purchases. As soon as inventory leaves your facility, it gets scanned by barcode into the updated inventory count, making cycle counts and other continually updating statistics possible.
Additionally, perpetual inventory keeps thorough purchase records that allow you to track and fix accounting errors more easily than with a periodic system. Instead of waiting to calculate the COGS at the end of the period, the perpetual system updates it after each sale.
There are downsides to perpetual inventory, however, mostly related to the cost and difficulty of managing extra systems. Complex computer programs are required to use the perpetual inventory method, which can be expensive and time-consuming. Additionally, since physical inventory counts are no longer used, certain processes, such as calculating inventory damage after a fire or flood, would be easier using the periodic system.
Which system should a business choose?
Accounting for inventory is a significant task in businesses of any size. Usually, the rule for choosing between the periodic and perpetual methods is to compare the business’s size and means to its needs. In short, is your business large enough to benefit from the higher costs of perpetual inventory management or small enough to utilize periodic inventory more efficiently? Whichever you choose, the right system is key to keeping either method competitive.