A business can track its inventory with either the periodic or the perpetual inventory system. With a periodic system, you update inventory in your ledger at the end of an accounting period, typically a year. Perpetual inventory systems update constantly. Perpetual inventory systems provide much more information, but there are advantages of the periodic inventory system.
Periodic and Perpetual
For a perpetual and periodic inventory system example, suppose your business sells handcrafted shelving. You order regular inventory shipments of wood, nails, paint and other raw materials and maintain a stockpile of finished shelving for sale.
With a perpetual inventory system, you need multiple ledger accounts to cover the value and costs of shipping raw materials, the raw materials themselves, finished shelves and shelving under construction. You have to update these accounts constantly as stock levels change and also update the cost of goods sold account.
A periodic inventory system is much simpler:
- Enter all purchases in a purchases account without separate accounting for raw materials and other categories.
- At the end of the year, quarter or other accounting period, you transfer the total purchases account into inventory.
- To wrap up the period, you take stock of your inventory with a physical count. You use the results to determine current inventory levels and the cost of goods sold.
Advantages of Periodic Stock Taking
Both the periodic and perpetual inventory systems check the stock of inventory at regular intervals. In a periodic inventory system, you take a stock count to measure inventory levels and see how they've changed.
With a perpetual system, you're always tracking inventory levels. Just the same, you need to take a stock count to double check that the inventory on the books is accurate. Errors, shoplifting and employee theft can all throw off your raw materials or inventory records.
Using a periodic inventory system doesn't stop you from keeping track of inventory between physical counts. Some businesses using a periodic inventory system have sophisticated tracking systems. They simply record the results separate from the accounts in their ledgers.
Advantages of a Periodic Inventory System
You can weigh the pros and cons of periodic inventory systems against perpetual inventory systems to decide which one works better for you.
The big advantage of going periodic is that it's simple. You update your purchases and related accounts between inventory counts, but everything else stays the same. This can work well if you only have a small inventory. It may even be possible to keep your records manually.
If your business has a high sales volume and a lot of turnover, you may find a periodic inventory system to be easier than keeping a constant count. With computers and barcodes in common use, though, it's much easier for a periodic inventory system to keep up with high sales than it used to be.
Periodic Inventory Drawbacks
When you compare the alternatives, you may find the advantages of a periodic inventory system don't make up for the downside.
- If you want to run lean by keeping just enough inventory on hand to meet demand, periodic inventory won't give you enough information about your stock levels.
- With less information about inventory levels, you may not spot a theft or fraud problem until the next physical inventory count.
- If inventory counts are off, periodic inventory systems probably won't have enough detailed information to track down the root cause.
- There's no way to adjust for obsolete inventory or waste between physical counts. When you take count at the end of the period, those accounts will see a large adjustment.
- Once your inventory rises above a certain size, the lack of accurate information about inventory numbers becomes a real problem.
Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com