A perpetual inventory system is a highly reliable system for industrial inventory management, warehouses, and large businesses with wide varieties of products or small to medium businesses looking to scale up in the future. It eliminates the challenges of physical inventory and missing stock understatements. We have outlined a detailed explanation of the perpetual inventory system, its mechanics, and its usage for your reference here.
What Is a Perpetual Inventory System?
A perpetual inventory system is a rigorous and comprehensive inventory accounting method that records inventory updation and changes in real time. It utilizes automated point-of-sale systems for a detailed rundown of the changes without physical inventory updation.
The system can be integrated with the marketing and sales software to analyze historical records to provide updates on the company's position in the market. The sales team can track live shipment details and manage potential hazards to provide a better experience to the customers.
The formula used by companies to track the ending inventory in a perpetual inventory system is as follows:
Ending Inventory = Beginning inventory + Receipts - Shipments
Here are some key points to remember regarding perpetual inventory systems:
- It accurately reflects the updates in inventory to track high-volume sales. It has developed into a more credible and practical option for businesses with technological advances in inventory systems and its integration with multiple applications.
- The system starts with actual data collection of products and updates purchases, shipments, and stocks.
- It involves a collection of software that works spontaneously to stay updated with the guidelines and provides accurate results effectively. Real-time information is a great ground for statistics and tax regulation for accounting teams.
- It also helps to track consumer behavior and the company's value in the market to meet diverse needs.
Perpetual vs Periodic Inventory System
Perpetual and Periodic Inventory System differ in terms of functionality and mode of operation. Both tools operate with different functionalities and processes. But, a perpetual inventory system is more complex than a periodic inventory system. It is because perpetual systems cater to more inventory records and in-depth stock details, whereas periodic systems cater to recording inventory regularly within specific intervals.
Perpetual systems are excellent for complex businesses and companies with vast inventories. However, businesses with simpler processes may opt to manage their stocks conveniently with periodic systems.
Here is the key difference between perpetual and periodic inventory systems:
Functionality
Perpetual inventory systems track the sales stocks automatically and constantly. There is a constant update in the system with every transaction. But, periodic systems track the sales and stocks every time a physical good is ordered at fixed periods across transactions.
Maintaining Records
Perpetual systems use a combination of software with point-of-sales mechanics to track thousands of payments. Periodic systems use point-in-time physical counts with manual tracking of the stock inventory.
Cost of Goods (COGS) Calculation
The perpetual system regularly tallies transactions and produces COGS timely. The periodic inventory system conducts a physical inventory check to calculate COGS towards the end of the accounting period. Thus, it cannot track quick and real-time COGS details.
Records Inventory
The perpetual system allows tracking of raw materials, shipping, inventory, or merchant accounts with its various software. Periodic systems track only purchases of physical goods in the purchase or asset account with no further details.
Advantages and Disadvantages of Perpetual Inventory System
Perpetual systems are superior to other inventory systems due to their easy installation and easy-to-understand mechanics. But, this system has some downsides that businesses must know to make the right decisions.
You can find some of the key merits and demerits of the perpetual inventory system below:
Advantages
Here are the advantages of a perpetual inventory system:
Time Effective Updates
Perpetual inventory systems are perfect for keeping real-time data updates for purchases, sales, and shipping of goods through their transactions. It waives the pressure off the managers and the correspondents working on the system.
Detailed Reports
Perpetual systems investigate the sale of goods to determine customer behavior, top choices, buying patterns, seasonal interferences with the inventory, and market fluctuations. Companies can use regular customer purchase behaviors to identify ways to minimize stock surplus or deficit and meet the demands without any losses.
Management of Finances and Statements
As perpetual investment systems provide regular updates on the inventory systems, it is easier to maintain financial records of debit and credit transactions. It speeds up the process and calculates the values in stocks accurately without manual calculations.
Reduce Time for Store Closures and Downtime
Important decisions like when to check and update the inventory, manage closing stores, timely employee progress, and more, can be taken conveniently with the perpetual system.
Multiple Assets Management
Perpetual systems are great for managing assets at multiple locations. They can easily be connected with other systems like sales and merchant accounts, and shipping management systems to tackle numerous actions simultaneously. You can also move stocks from one place to another with a perpetual inventory.
Disadvantages
Costs
Perpetual systems may be expensive due to the costs of software training of staff, employed equipment, regular technological updates, and maintenance.
Absence of Physical Inventory
As the perpetual inventory systems do not rely on the physical purchase or goods to be counted in the transactions, there is often no physical inventory to provide a physical count of goods sold in the financial records. Thus, the need to reconcile items with physical inventory must be regulated with this system.
Prone to Hacking
Perpetual inventory systems are entirely dependent on computer software and systems, making them susceptible to security and data loss risks if reliable systems are not updated. Perpetual inventory systems must be complemented with strict cyber security protocols and measures that may increase the overall implementation costs.
Loss of Inventory Stocks
Perpetual inventory systems may not be capable of detecting physical inventory changes unless they incorporate advanced tracking mechanisms. It makes it challenging to detect changes like damage, theft, spoilage of goods, and loss of goods in shipment.
Error in Tracking
Suppose the employee and the manager are not well equipped with the technologies involved in the perpetual inventory systems. In that case, it increases the scope of misplacement of the wrong alignment of products, detecting errors, software errors, and more. It can lead to discrepancies in business operations and require regular physical inventory checks.
How Does the Perpetual Inventory System Work?
A perpetual inventory system tackles inventory management by updating the system every time a transaction is incurred in the database. Unique product identification is crucial to provide the sole identity of the product and track its location, quantity, type, category, and other details.
Perpetual systems simplify forecasting demands and simultaneously re-evaluate historical records and past sales to determine future objectives, sales trends, and highest-selling products. It is great for businesses to manage seasonal holidays, peak months, and festive deals by maintaining the optimum level of inventory.
To ensure business success, features of perpetual inventory systems include tracking facilities like a unique tracking code called the Radio-Frequency Identification (RFID) code or Barcode.
Process of Product Registration With New Products
The company owners can use the following process to establish the inventory system:
- The employees must register the new product into the computer database system.
- Add the details like the name, type of product, a unique product code or RFID code, or other additional information used by customers to identify the product.
- Employees categorize and scan the products into the computer database. The database enters the details under the subheading of product type, quantity, and other details.
Perpetual inventory systems are a common practice in businesses where thousands of products are handled and categorized daily and transported to the supply chains. It makes it easier for managers to manage their product inventory and ensure customer satisfaction and gratification.
Process After Registration
Once the product is registered in the database, the system starts tracking its record.
- When a customer purchases a product, the database automatically informs that there is one less product unit in the warehouse.
- The database does not require the physical presence of the employees to check the inventory.
- Store managers can use it to renew the products when there is a shortage or excess of inventory.
Mechanism of Perpetual Inventory System
The perpetual inventory system works on the following principle once the product registration is completed:
- The automated system eliminates the need for human error in working and reduces labor costs in inventory management.
- When a product is sold, the point of sale function notifies the perpetual inventory system.
- The system detects a debit in the inventory and updates the information across all platforms and software connected to the perpetual inventory system.
- The use of barcodes and RFID is crucial to identify the product and bifurcate the product whose unit is sold.
- The perpetual inventory system is connected with other functions such as marketing, shipping, and other systems to handle multiple phases of product management.
- The formulae in the system work simultaneously to conceptualize the cost of goods sold and update the data.
- The perpetual inventory system completes calculations and alerts the business team when there is a requirement for restocking or the arrival of new stock.
- The system not only captures the new data to maintain the order details, but it also reads the previous information to keep data updated on the inventory levels and whenever there is a need to reorder units of a product.
- The updated order details are supplied to the manufacturer and supplier to receive the requirement for the new purchase order.
When to Use Perpetual Inventory System?
Businesses with a large inventory and businesses looking to scale up must invest in a perpetual inventory system due to its real-time analysis and awareness of changes happening in the inventory. It is perfect for businesses that wish to keep a robust track of the exact number of units in stock at all times.
Other factors to consider are the profit margin, the size of inventory to manage, and the ability of vendors to tackle various methods of inventory management.
A perpetual inventory system is excellent for varying sizes of businesses. It is estimated that the perpetual systems are the future of inventory, as they are economical and easy to implement effectively across small, medium, and large businesses.
How to Use a Perpetual Inventory System?
Once a business has decided to use the perpetual inventory system over a manual periodic system, the need for the right software and technologies arises. The companies and their partners must create an optimized inventory tracking system to cater to order fulfillment and its responsibilities.
Procedure to set up a perpetual inventory system:
- Perpetual systems operate on a point to sale mechanics. Make sure to set up a comprehensive system to detect the inflow and the outflow of stocks.
- Enabling a physical inventory reconciliation functionality along with a perpetual system maximizes the benefits of a perpetual inventory system, as this system does not track physical goods and only credit and debit transactions. Further, tracking actual or physical inventory allows the company managers and the employees to update and match the physical goods corresponding to each transaction incurred in the perpetual inventory system.
- Make sure to practice strict inventory management protocols and devise a rigorous process to track any errors.
- Adopt the right inventory management techniques that streamline all operations involving the raw materials, labor, capital, and other technological costs incurred on the products, storage, and market sale fronts. Some of the inventory management systems are just-in-time management (JIT), days sales of inventory (DSI), and economic order quantity (EOQ). Effective Inventory management also involves understanding the safety measures and formulas employed in perpetual inventory.
Formulas and Control Measures in Perpetual Inventory:
Perpetual inventory systems follow a defined set of protocols and formulas to check inventory status. The formulas detect when to order more stock, the quantity and time required to add more inventory, the average time taken by customers before placing an order, and its safety measures.
Here are the important formulae that companies must know to make the most of perpetual systems.
Economic Order Quantity Formula
Economic Order Quantity (EOQ) Formula calculates the optimum level and inventory costs required to upkeep the customers' demands. It contemplates the costs to store the inventory with the cost price of the products.
EOQ = √2DS/H where D stands for the Demand in units per year, S = Order Cost per purchase, and H is the Holding Cost per unit per year.
Costs of Goods Sold Formula
Costs of Goods Sold (COGS) are the direct production expenses incurred on the cost of goods sold. Some of the key elements, like the expenses of the raw materials, labor, and capital, are included in the COGS minus the sales or distribution prices.
Calculate the beginning inventory (BI), i.e. the previous remaining stock or the zero inventory. Add the accounting months, quarters, or the entire calendar year and leave the ending inventory towards the end of the accounting period to know the expenses incurred as the cost price of the goods.
COGS= BI + P - EI, where BI is the Beginning Inventory, P is the Purchases for the period, and E concludes the Ending Inventory.
Gross Profit Formula
Gross Profit determines the overall profit margin incurred by the company on the ending inventory in a stipulated period. You can use this to plan the beginning inventory, future purchases, and inventory requirements in the business.
Gross Profit = Revenue - COGS
Should You Opt for a Perpetual Inventory System for Your Business?
A Perpetual Inventory System is great for businesses with large and complex inventory categories. However, a small or medium-scale business looking to get a hold of its profits, margins, and stock to scale up the business can also take advantage of this inventory system. The ability of the system to track the products and transactions one by one ensures proper descriptive analysis of the stock.
FAQs on Perpetual Inventory System
1. Why do companies use a perpetual inventory system?
Companies use a perpetual inventory system as it is a robust system providing real-time updates on the number of goods and avoiding shortages. It can be integrated with other business components to understand consumer behavior information as well.
2. Does LIFO fall under a perpetual or periodic inventory system?
Last-in, First-out (LIFO) stands for the cash flow assumption kept to evaluate the business stock. LIFO presumes that newer stock is sold before the older stock. It is considered under a perpetual inventory system as the transactions are recorded in real-time with regular updates.
3. What are the types of perpetual inventory methods?
Key perpetual inventory methods include First-in, First-out (FIFO), LIFO, and Weighted Average Cost systems.
