What is a Periodic Inventory System? When and How to Use Periodic Inventory Control?
Inventory management systems impact every element of business operations, from order fulfillment and revenue generation to warehouse and overhead costs.
Perpetual and periodic inventory systems are two techniques for managing inventory. While perpetual systems update inventory after every transaction, periodic inventory control accounts for checking inventory levels at regular time-based periods.
A periodic inventory system is the easier of the two approaches to adopt, needing less time, money, and resources.
The physical counting approach to the inventory management system is through periodic inventory system techniques. It is done regularly to determine inventory data that affect the cost of goods sold.
Periodic inventory control is a difficult task that requires time and effort. As a result, small enterprises with little need for inventory typically use the periodic inventory approach. However, companies of all sizes may use the periodic inventory control method.
Let’s talk about a periodic inventory system and how it might aid with inventory control.
- What is a Periodic Inventory System?
- Explaining Periodic Inventory Control System
- How Does A Periodic Inventory System Operate?
- Challenges of Periodic Inventory System
- Advantages of Periodic Inventory Control System
- Disadvantages of Periodic Inventory Control System
- How Does the Periodic Inventory System Calculate Cost of Goods Sold?
- Periodic vs Perpetual Inventory Systems: Which is Better?
- Periodic Inventory System FAQs (Frequently Asked Questions)
What is a Periodic Inventory System?
The periodic examination of inventory is referred to as part of the periodic inventory management system. After a predetermined amount of time, such as monthly, quarterly, or yearly, inventory is physically counted.
After one accounting quarter, businesses do the routine inventory count. The commencement of the subsequent accounting period subsequently starts with the data for the ending inventory.
Businesses that use periodic inventory systems update their general ledger accounts for the ending inventory after each physical count. With successive journal entries, all other entries are connected to the accounts for purchases and payables.
Businesses may also have a freight expense account. It enables them to accurately reflect the expenses of the cost of the items offered. Every time the company receives new goods, the account is updated. A firm finally uses the account to determine final inventory costs.
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Explaining Periodic Inventory Control System
To ascertain the amount of inventory on hand and the cost of products sold, a corporation using a periodic inventory system physically counts the inventory after each period. Many businesses pick monthly, quarterly, or yearly intervals depending on their product demands and bookkeeping.
Businesses use the starting inventory level, the ending inventory level, and the purchases made during that period to calculate costs rather than continually updating their records with current inventory and cost levels.
Businesses that don’t have a daily requirement to correctly know their current inventory levels might benefit from periodic inventory. For small enterprises that want to keep prices down, it works effectively. However, larger and expanding companies often choose a permanent inventory system, which is best managed by an ERP inventory module since they require more comprehensive inventory management.
Many small firms, especially those with few unique SKUs to update at the end of each quarter, do just fine with periodic inventory, even if it does not provide business decision-makers with real-time data.
Periodic Inventory System: When to Use It
The cost of products sold and the precise amount of goods in inventory are typically unknown to businesses using the periodic inventory method until a physical count is done. For this reason, the system is advised for companies with a limited number of SKUs operating in a market that moves slowly.
Companies that lack the resources or do not want to spend a lot of money on implementing a more intricate inventory accounting system are also advised to use the system. It could be the most incredible option for new businesses, especially those with substantial inventory made up primarily of inexpensive commodities.
Periodic Inventory System: When Not to Use It
The periodic Inventory System method might not be suited for large enterprises due to the high amount of inventory transactions. This is because large organisations must continually track the number of items in their inventory to make essential purchase choices.
Who Uses a Periodic Inventory System?
Small firms that handle a modest number of transactions or enterprises with a small inventory are the primary users of the periodic inventory technique.
These businesses typically choose a periodic inventory system since it is easier to operate and more cost-effective because their sales and costs are simple to control.
These enterprises include modest cafés, restaurants, auto dealerships, art galleries, and so on.
How Does A Periodic Inventory System Operate?
Physical inspections of the inventory are done using the periodic inventory control system. Since most of these jobs are done by hand, the process takes time and is expensive. As a result, businesses with significant inventories must allocate personnel and time each time a physical inventory count is conducted.
A periodic inventory system uses a different accounting procedure than other systems like perpetual inventory. A temporary account for purchases in a periodic system serves as the foundation for inventory accounting. After purchases, the inventory account is not immediately deducted.
The business first enters all new purchases into a temporary purchasing account. The firm then conducts a physical inventory count. The main inventory account is then given the statistics from the purchases account. The cost of goods sold estimates are then updated using these data.
Then, using the initial inventory data, new purchases, and subtracting the ending inventory figures, the Cost of Goods Dold (COGS) is determined.
The formula for cost of goods sold:
COGS = Beginning inventory + New Purchases – Closing Inventory
In rare circumstances, the business can substitute beginning inventory for the ending or remaining balance of inventory from the prior accounting period.
Challenges of Periodic Inventory System
Even though periodic inventory is simple to execute, there are several significant downsides regarding the quantity of detail you receive and how frequently your data is updated.
Most business owners and managers require up-to-date information daily to make wise business decisions. With each sale or shipment, most large enterprises immediately update their inventory. With a contemporary ERP, this is simple to accomplish. When you buy anything in a physical shop or online, the merchant has complete knowledge of what was purchased and when allowing them to plan for restocking.
When periodic inventory is in place, businesses might not be aware that a product is running low until a client inquires why it isn’t on the shelf. Even worse, you may sell something online only to discover that your supplier has back-ordered it because it is out of stock. Both provide customers with less than optimal experiences, which may also be stressful for your team.
Many small firms have inventory management systems connected to their POS or online store. The inventory is automatically updated when the cashier scans a barcode, and a customer leaves with a purchase. To ensure they never run out of supply, sophisticated firms may set up automatic reordering.
The continuing data assists firms in maintaining more detailed data on cost per item sold, which plays a significant role in profit margins and overall profitability. Operating using a periodic inventory method is like running your firm while wearing blinders for huge businesses or developing enterprises. The whole image won’t become clear until the conclusion of the time period.
Advantages of Periodic Inventory Control System
The periodic inventory approach was very well-liked before technology accounting solutions were introduced. There was no denying its shortcomings, but most business owners believed its advantages exceeded them.
It’s interesting to note that the method is still widely used today, and many business owners prefer it to the perpetual inventory system. However, one may be justified in supposing that the periodic inventory system has just as many detractors as supporters. This is due to the firm belief held by specific individuals that it is undesirable to submit your company to a management tool that may produce unpredictable outcomes.
To ensure you are making an informed decision, the benefits of the periodic inventory system have been listed below.
Excellent Choice for Small Businesses
Smaller companies that don’t retain a lot of stock in their inventory are best suited for a periodic inventory system. A physical inventory count is simple to complete for such firms. Estimating the cost of commodities sold over predetermined periods is likewise much simpler.
This indicates that other techniques are more appropriate for businesses with a high inventory turnover rate, a high number of SKUs, demands for multichannel inventory management, or who want real-time data.
Simple to Implement
The simplicity of periodic inventory systems is prized, and all that’s required to physically count your beginning inventory at specific periods throughout the year is a little time. As a result, a periodic inventory technique may be adopted without much planning or preparation because it doesn’t need complex calculations or accounting records.
Minimal Resources and Costs
Spreadsheets may be used to do periodic inventory instead of inventory management software, eliminating the need for additional software or training expenditures. Additionally, since the stock is only updated occasionally, more resources are available for other corporate operations.
Reduced Inventory Records
A periodic inventory system might work for companies with a single location or few product lines. Estimating the current inventory levels and keeping track of sale transactions are relatively simple tasks. A straightforward inventory system will also be simpler to administer and keep up with over time.
Disadvantages of Periodic Inventory Control System
Remember that the advantages listed above mainly profit small enterprises that handle a few hundred transactions annually.
The periodic inventory method becomes complex and challenging to maintain as stock levels increase and your business expands. Because of this, not every firm may benefit from the strategy; most companies instead employ perpetual inventory.
And that’s one of the system’s drawbacks, amongst others, which are listed below.
Prone to Human Mistakes
The possibility of a human mistake increases when you physically count all the inventory goods you have on hand. There might be mistakes in the value or the total inventory count. Any errors will also be carried over to the next quarter. After taking stock of all inventory, look for anomalies or statistics that seem noticeably higher or lower than anticipated to avoid this.
Difficult to Scale
Periodic inventory is a very manual procedure that may be time-consuming and challenging to scale as a firm expands. A bottleneck may develop during an inventory count if all goods must be put aside for an extended period.
Moving from a periodic inventory system to an automated perpetual inventory system may be worthwhile as your product lines expand and new locations open.
Less Control and Informational
In periodic inventory, only the time records at the start and end of the period are entirely correct. A company relies on predictions of its present inventory levels for the remainder of the time. One may lose sales and customers if inventory is too low or if an unnoticed discrepancy in the accounts. A lack of real-time data may hamper other business choices.
Does Not Permit Modifications
A firm may occasionally encounter product recalls, purchases return, and misplaced products in transit. However, there is no way to consider these unforeseen changes with the periodic inventory. Therefore, up to the conclusion of the next term, inventory records remain fixed.
How Does the Periodic Inventory System Calculate Cost of Goods Sold?
To get the total cost of the products available for sale, add the inventory amount at the start of the year to the amount displayed on the Purchases account. You can utilise the quantity of stock left at the end of the prior period if your company doesn’t have a defined beginning inventory level.
This computation uses the following formula.
Cost Of Goods Available For Sale = Beginning Inventory + New Purchases
The physical count of each item in the inventory is then used to establish the ending inventory. Finally, you can calculate the cost of the ending or closing inventory using the weighted average price, first in, first out, or last in, first out.
The cost of goods sold is then calculated by deducting the previously tallied ending inventory from the total price of the commodities offered.
The second formula for calculating the Cost of Goods Sold (COGS) is the following.
COGS = Beginning inventory + New Purchases – Closing Inventory
This can all seem a little complex, so let’s use an example to clarify the idea and demonstrate how to use these computations.
Let’s imagine that a corporation that sells items has a periodic inventory system and assesses its inventory at the end of the financial year. As a result, any adjustments to inventory resulting from sales or acquisitions made by the company during the year are not recognised until March 31st.
Now suppose that March 31st has arrived, and the following data is accessible:
At the start of the year, the beginning inventory amounts to $50,000.
The total amount spent on items for the entire year is $125,000.
The final ending inventory is priced at $30,000.
The COGS calculation for this data would be as follows:
So, Beginning Inventory + New Purchases = Cost Of Goods Available For Sale
$50,000 + $125,000 = $175,000
Beginning inventory + New Purchases – Closing Inventory = COGS
$175,000 – $30,000 = $145,000
Cost of Goods Sold = $145,000
Periodic vs Perpetual Inventory Systems: Which is Better?
Which is better, the perpetual or periodic inventory control system? It is a topic that is frequently discussed. It’s crucial to note that both approaches are recognised by the General Accepted Accounting Principles (GAAP).
This section will cover how the two systems differ and which approach is most appropriate based on your company’s business strategy.
Due to the development of tools like barcode scanning and inventory management software over the years, the perpetual inventory system has grown in popularity. However, most small business owners appear to have a soft place for the periodic inventory system.
It’s crucial to comprehend exactly what a perpetual inventory system is before we discuss its distinctions.
Through point-of-sale inventory systems, the perpetual inventory system keeps track of inventory by immediately documenting any alterations. In addition, continuous inventory taking is made possible because the systems maintain a running account that is updated with each sale or return.
Differences Between Perpetual And Periodic Inventory System
- The most crucial distinction between the two systems is that the perpetual inventory system permits ongoing inventory counting. In contrast, the periodic system counts inventory once, after a specific accounting period.
- In businesses, when there aren’t a lot of products being sold, the perpetual method is frequently employed. Due to its simplicity, smaller firms with extensive stock typically use the systematic approach.
- Due to its partial dependence on technology, such as bar code scanners, the everlasting system may be costly. However, you won’t incur any further expenditures because the systematic method allows you to count your finishing inventory physically.
- Since issues are discovered in real-time by the perpetual system’s continuous surveillance, they may resolve them more quickly if they already exist. After the accounting period, when it could already be too late, the periodic system would only be able to detect underlying issues.
- The perpetual system’s digital foundation makes it possible to back up data, quickly organise it, and even manipulate it to provide reports with plenty of specific information. On the other hand, the periodic system relies on manual labour, making it possible for a human mistake to result in data loss or misplacing.
- The perpetual inventory method doesn’t interfere with a business’s regular activities. However, depending on the number of products being tallied, the periodic system will interfere with company activities, especially on the day of the physical count.
- Thanks to the perpetual system, you will always have access to precise COGS numbers. However, with the systematic approach, you would have to wait until the physical count was done to obtain the exact COGS during an accounting period.
- You could need to hire many tech-savvy workers with expertise with the everlasting system or give your current staff substantial training to use it. However, the systematic approach is praised for its simplicity and would not need additional training for the team.
Selecting One of the Two
Small business owners’ activities are often restricted to the cash register and fairly straightforward accounting procedures. Therefore, small business owners would benefit most from the periodic inventory system.
You wouldn’t need an inventory management system for companies that only supply services rather than items. This is, of course, unless you are in the hospitality sector, running a restaurant, or you have inventory products that need to be tracked, such as food or medications.
But if a company grows, switching to a permanent system could be necessary since it gives you access to the cost of goods sold whenever you need them. In addition, you may use it to spot any stock flaws and take the appropriate action instantly.
Due to the high amount of inventory transactions they handle and the automated nature of their accounting systems, most influential organisations favour the perpetual inventory system over the systematic approach, as was previously mentioned.
One of the most straightforward accounting procedures that enable a corporation to track its entire inventory is periodic inventory systems.
Periodic inventory can be sufficient for a firm handling fewer goods, but it may be too basic for businesses with significant or changing sales volumes.
Businesses frequently mix the two accounting techniques to manage inventories. While a periodic count is performed at predetermined intervals to confirm the correctness of all accounts in the inventory ledger, a perpetual inventory system is utilised to record all daily inventory movements instantaneously. If you need assistance with periodic inventory systems or any other eCommerce requirement, you can opt to partner with WareIQ.
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