Should your business use a perpetual inventory system or a periodic inventory system? What is the difference between the two inventory management systems? Most small businesses still use periodic inventory management, although perpetual inventory management is becoming increasingly popular. Development of more sophisticated computer scanning of inventory has allowed regular use of perpetual inventory systems by companies. More and more businesses use scanners at the point of sale. According to the generally accepted accounting principles (GAAP), companies can use either perpetual inventory systems or periodic inventory systems.
What is a Perpetual Inventory System?
A perpetual inventory tracking system is a method of immediately accounting for inventory sales in the inventory account, if there is no theft or spoilage. It is an inventory management system where store balances of inventory are recorded after every transaction. It eliminates the need for the store to close down constantly for inventory stock-taking as perpetual inventory systems allow for continuous stock-taking. Perpetual inventory systems keep a running account of the company's inventory.
Perpetual inventory systems involve more record-keeping than periodic inventory systems. Every inventory item is kept on a separate ledger. These inventory ledgers contain information on cost of goods sold, purchases, and inventory on hand. Perpetual inventory management systems allow for a high degree of control of the company's inventory by management. Perpetual inventory management is generally used by companies who have the ability to scan the inventory items sold and who use point-of-sale inventory systems.
Perpetual inventory systems provide the business owner with a record of what is sold, where it was sold from, when it was sold, and for what price it was sold. As a result, it allows for businesses to have more than one location with one centralized inventory management system. Even with a perpetual inventory management system, the company still needs to shut down at least annually to do a periodic, or manual, inventory count. The scanned data should tell the business owner exactly what inventory should be on hand. The major advantage of doing a periodic inventory count is to determine how much inventory has been lost, stolen, or subject to spoilage.
What is a Periodic Inventory System?
A periodic inventory system does not require day-to-day tracking of physical inventory. Purchases, cost of goods sold, and inventory on hand cannot be tracked until the end of the accounting time period when a physical inventory is performed and ending inventory is compared against the sum of beginning inventory and purchases. Cost of ending inventory can be calculated by using the LIFO or FIFO inventory accounting methods, or other less common methods.
Periodic inventory management allows a company to know beginning inventory and ending inventory but it does not track inventory on a daily basis. This means there is lost information. Business owners cannot tell if inventory was sold or if it was stolen, lost, or spoiled. Using the periodic inventory management system, end-of-period inventory is calculated according to the following formula:
*Beginning Inventory + Purchases – Cost of Goods Sold = Ending Inventory
*Beginning Inventory is ending inventory from the previous time period
Which is Better - Perpetual or Periodic Inventory Management?
If you own a start-up business without much money, periodic inventory management is definitely better because you can get by with just a cash register and a simple accounting procedure. If you sell services rather than products, you may not need an inventory management system unless you own a restaurant or you are in the hospitality business.
As your business grows, you will probably want to switch over to a perpetual inventory management system as it allows you to know the balance in your inventory account at any point in time. Large businesses typically have perpetual inventory systems rather than periodic inventory systems since the rest of their financial and accounting systems are computerized.