Many companies use inventory systems in their production or retail operations to manage inventory levels. Inventory might be one of a company's most valuable assets and systems to manage it provide the foundation to meet customer demand. Each inventory system falls within a specific scope and has certain limitations that management must understand in order to choose the best system for the company.
Inventory systems provide a basis for recording sales, purchases. and the quantity for each item at the end of the accounting period. The two primary inventory systems are the periodic system and the perpetual system. The periodic system records the inventory only at the end of each period, leaving the balance unchanged throughout the period. Since counting inventory takes time, smaller businesses are more likely to use the periodic system. The perpetual system, in contrast, adjusts the inventory balance each time a transaction, such as an inventory purchase or a sale, occurs, and it provides real-time information.
The scope of an inventory system can cover many needs, including valuing the inventory, measuring the change in inventory and planning for future inventory levels. The value of the inventory at the end of each period provides a basis for financial reporting on the balance sheet. Measuring the change in inventory allows the company to determine the cost of inventory sold during the period. This allows the company to plan for future inventory needs.
The limitations of the periodic system include not knowing an exact inventory count in the middle of the period and running the risk of stockouts. With the periodic system, the company knows the inventory level with certainty only when it physically counts the inventory at the end of each period. Throughout the period, the company takes customer orders without knowing the exact inventory count or whether enough products are available to meet customer demand.
The limitations of a perpetual inventory system include a false sense of reliability and dependence on human entry. Although a perpetual system updates each time a transaction enters the system, it might lack information regarding stolen, damaged or scrapped units. The company remains unaware of the theft or waste, known as shrinkage, until it performs a physical count at least once per year. The other limitation is that an employee might enter data incorrectly, introducing inaccurate information that can compromise decision-making.