written by | May 30, 2022

What Is Perpetual Inventory? Advantages and Disadvantages Explained

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The perpetual and periodic inventory systems are two methods used to track the number of stock products. The more advanced one is called the permanent system. However, it is more demanding for records to keep. The periodic system is based on periodic physical inventory counts to determine the balance at the end of the Inventory and the price of products sold. In contrast, the perpetual system maintains a continuous record of inventory balances.

Did You know?

Perpetual inventory can help in stock marketing as well. Yes, it’s known as the perpetual inventory system/perpetual stock taking. This is a sort of valuation inventory in which a business employs electronic systems for tracking to keep recording the inventory frequently. Small businesses can give a try to such stock management methods to attain success.

Also Read: Everything You Need to Know about Inventory Costing Methods

What Is the Perpetual Inventory System Meaning?

A perpetual inventory system does not rely on physical inventory counts to make accounting adjustments, and it also does not require an end-of-year entry of all inventory items. The accounting records should be accurate, and if they are not, errors may cause discrepancies between the book and the actual Inventory. Physical Inventory is important because mistakes can be made, and even theft can occur.  

In a physical store, the point-of-sale (POS) system is used. It allows a team member to scan items for sale, update the inventory count and process payments. The POS system also generates a digital receipt for each transaction. A perpetual inventory system updates cost-of-goods-sold and Inventory levels automatically. This is a very efficient way to manage Inventory.

The Advantages and Disadvantages of Perpetual Inventory

The Advantages of a Perpetual Inventory System are as follows:

  • This system also lowers inventory management costs, enabling you to predict demand better. 
  • A perpetual inventory system provides a comprehensive data set for inventory metrics, making analysis easier. 
  • Perpetual inventory systems can scale storage costs according to demand. You can optimise your store's inventory management by adjusting storage costs and reducing your business' Inventory.
  • You can avoid storing items past their expiration dates.

On the other hand, some cons may include:

  • Set up cost is high, and employees need extra training to use the system.
  • Fixing the error can be daunting and time-consuming if the employees make mistakes or fail to be accurate while entering the Inventory.
  • Mistakes like entering the wrong quantity may lead to incorrect inventory levels.

 

Who Uses a Perpetual Inventory System?

If business owners or managers require accurate information regarding the inventory levels, then a perpetual inventory system is the best option.

Smaller businesses that want to expand or have more control over their product might also consider the perpetual option. There are various user-friendly and affordable perpetual software choices available on the market.

Advantages and Disadvantages of Periodic Inventory System

The advantages of using the periodic inventory system are clear: 

  • In contrast, a perpetual inventory system provides managers with real-time information about inventory levels, allowing them to make informed decisions.
  • You can count Inventory more frequently, which reduces the risk of damage or shrinkage of merchandise. 
  • The periodic system is useful for retail businesses that deal in low-value Inventory, and it can save businesses a lot of time and effort. When implemented correctly, the system counts Beginning Inventory and Ending Inventory.
  • Moreover, the periodic system does not require real-time records of purchases and customer sales. 
  • It eliminates the need for a continuous inventory record. Instead, you keep separate accounts for beginning and ending inventory, as well as for on-hand Inventory.
  • Periodic Inventory is easy to implement. Instead of entering a new price for the goods you have in stock, you simply make a purchase and deduct it from the cost of goods sold.

The disadvantages of using the periodic inventory system are:

  • The disadvantages of this system make it difficult to track inventory costs or make present-day business decisions. 
  • You should keep in mind that the physical inventory count may differ from the inventory count in the software.

 

The formula for a periodic inventory system is the cost of finished goods sold equals the Cost of Goods Sold minus Ending Inventory.

Also Read: Inventory Valuation Meaning and its Importance | Read Now!

Perpetual Vs. Periodic Inventory Systems

There are a few things to consider when deciding between periodic and perpetual inventory systems. For example, the perpetual system keeps a continuous record of inventory transactions, and the periodic system updates the cost of goods sold at the end of every financial period. Regardless of which system you choose, there are certain common features that both systems share. 

Difference 1

A perpetual system requires periodic physical counts, which can be good for small businesses. It can be very difficult for larger businesses to perform such physical counts, especially if they have hundreds or thousands of products. 

This method typically requires a physical count every week, daily, or on-demand. However, periodic systems can have long gaps between physical counts, making accurate cost-of-goods-sold figures a problem.

Difference 2

The main difference between the two is the way Inventory is recorded. Perpetual systems record all inventory transactions in real-time, and periodic systems record inventory at the end of every period. 

This makes a perpetual system more efficient than the periodic inventory systems, which use physical counts to record Inventory. While both systems are effective, you should choose the right one for your business.

Difference 3

A perpetual system is a better option for companies that need to monitor inventory levels closely. With this type of system, you can keep track of transactions and make accurate financial reporting.

You can choose between periodic and perpetual inventory systems in inventory tracking. Both methods help companies understand their Inventory while relying on periodic physical counts. 

Formulas in Perpetual Inventory

Formulas for managing Inventory can inform you when you should order more Inventory, the time you need to wait before placing your order, the quantity to purchase and the quantity of stock you need to maintain in a safe place.

The Cost of Goods Sold (COGS)

At a basic level, the COGS formula is: Starting Inventory plus purchases − ending Inventory = COGS.

Gross Profit

The gross profit formula is Revenue – Cost of Goods Sold = Gross Profit. 

Gross Profit Method

Profit is computed in a different manner in the perpetual inventory system. To calculate the gross profits, you may need to estimate the inventory value used while making accounting statements and documents.

This is how using the method of gross profits will be if you want to estimate the inventory ending of the month you are.

It is important to be aware of that

  • Gross profit in the percentage of sales
  • Inventory beginning for the period
  • Purchases made during that time
  • The total sales during that period

Using this method, you will be able to determine the estimated end of Inventory and the net you've earned.

The FIFO Perpetual Inventory Method

The FIFO inventory method increases sales costs, also known as COGS. This measure of the cost of goods sold (COGS) accounts for the total labour and materials costs minus distribution costs. The COGS calculation is based on the amount of stock left in Inventory at the end of the accounting period, months, quarters, or calendar year. Each time a transaction is made, the COGS is calculated again. In addition, COGS is a measure of cost for a business.

FIFO uses the oldest Inventory at the time of sale. In this method, you must calculate the Cost of Goods Sold for each sale, which is a rollover from the ending balance of the last period. For example, a car dealership would want to report the exact cost of a BMW convertible, so it would be good to use specific identification to determine how much the car costs.

  • Additional Inventory is added to the merchandise inventory account. 
  • FIFO (first-in, first-out) refers to the principle of stock-based accounting. Using the method, you record inventory sales and assign the cost to each unit. 
  • This method is more comprehensive than other methods, as it keeps track of the cost of purchases and the actual inventory count. 
  • With modern information systems, you can accurately track the cost of your merchandise and its Inventory.

What Is LIFO Perpetual Inventory Method?

LIFO perpetual inventory method of accounting is often used in retail and wholesale businesses. Its principle consists of estimating ending Inventory based on the beginning inventory and the costs of purchases. 

  • This method is particularly useful for companies that track costs of delivery. 
  • This method assigns the cost of goods sold to the most recent purchased or produced Inventory. Also, this method is used in both a perpetual and periodic inventory system.
  • When used properly, LIFO is extremely useful for maintaining inventory levels.
  • Depending on the method, sales of items come from the top layer, and those that have not sold yet remain in the bottom layer. 
  • The last-in-first-out method is an inventory technique that is popular among companies with high inventory costs.
  • Companies purchase items at different costs and charge different prices in a LIFO system. 
  • This method is more efficient for businesses that have high inventory turnover rates. The stock cost is much higher in perpetual LIFO, but the benefits are worth it.

Conclusion

You've decided to start a small convenience store in your town. In the initial setup process, you must determine if you prefer a periodic inventory system or a perpetual inventory system. Choose the system that is the most appropriate for your company, and back your decision with research. 

Now keep track of your cash flow and manage your incomes and expenses with ease by using the Cashbook app by Khatabook.

FAQs

Q: How do you calculate the weighted average in accounting?

Ans:

To calculate the weighted average cost, divide the total cost of goods purchased by the number of units available for sale.

If you want to calculate the average cost of weighted, just divide the entire expenses of goods bought by the unit numbers accessible for sale.

Q: What is a perpetual FIFO calculator?

Ans:

If you want to calculate FIFO (the full form is First-In & First Out), start by identifying your most recent inventory and multiplying those expenses of inventory sold.

Q: What is perpetual inventory management?

Ans:

A perpetual inventory system is useful for inventory management as it keeps the record of when stock gets sold or you receive any stock. The inventory management system can automate the process and work in real-time.

Q: What can be a perpetual inventory system example?

Ans:

If you want to know about the perpetual inventory system, it helps you keep a continuous track of the balances in your inventory. Also, it automatically gets updated when you sell or receive inventory.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.