![What Is a Periodic Inventory System and How Does It Work? [With Examples]](https://blogimages.softwaresuggest.com/blog/wp-content/uploads/2023/10/10110710/What-Is-a-Periodic-Inventory-System-and-How-Does-It-Work-With-Examples.jpg)
Key Takeaways:
- Periodic inventory systems offer simplicity and cost-effectiveness, making them ideal for smaller enterprises with less complex inventory needs. It involves scheduled physical inventory counts at predetermined intervals, ensuring accurate stock tallies, and maintaining precise inventory records.
- The periodic inventory method follows a series of essential steps, including initial inventory counts, separate transaction recording, periodic physical counts, calculation of Cost of Goods Sold (COGS), adjustments, and financial reporting. It benefits businesses seeking a balance between accuracy and resource allocation, fostering operational efficiency.
- Periodic systems involve intermittent physical counts, while perpetual systems offer real-time tracking through automated software. The choice between these systems depends on a company’s needs and resources.
Businesses use various inventory management systems to keep track of their inventories, guaranteeing a smooth operation and clear financial reporting. Owing to its wide use, the inventory management software market is expected to reach $US 3291.1 million by 2028, growing at a CAGR of 11.2% for 2022-28.
Looking for Inventory Software? Check out SoftwareSuggest’s list of the top inventory & stock management software.
Perpetual and periodic inventory systems are widely used systems. Unlike its counterpart, the perpetual inventory system, which constantly updates inventory levels in real time, the periodic inventory system takes a different approach. It involves periodic intervals of physically counting and reconciling stock to determine the quantities on hand.
In this article, we will examine the periodic inventory method’s workings, consider the benefits and drawbacks, and offer illustrations to explain how it functions. So, let’s begin understanding its intricacies and role within the broader landscape of inventory management.
What Is a Periodic Inventory System?
A periodic inventory system is a method businesses use to manage and track their inventory levels. This approach offers simplicity and cost-effectiveness for smaller enterprises with less complex inventory needs.
Companies that use a periodic inventory system regularly count their inventory at predetermined periods, like monthly or quarterly. These physical counts tally the real stock of products and compare them to the recorded quantities. The correction of discrepancies aids in maintaining accurate inventory records.
When considering an inventory management system, tailor your choice to your business needs. Opt for a periodic inventory system if you're a small enterprise seeking simplicity and cost-effectiveness. Balance benefits like reduced operational costs and streamlined training against drawbacks such as potential inaccuracies. Choose wisely to match your business goals and resources.
Businesses seeking a balance between accuracy and resource allocation can manage stock using a periodic inventory method, which is simple but effective.
How Does Periodic Inventory System Work?
Under a periodic inventory system, businesses utilize periodic or intermittent updates of inventory records to conduct a physical inventory count at fixed periods, generally monthly, quarterly, or yearly. The changes in stock levels are then calculated by comparing this count to the initially reported inventory balance. The inventory process can be divided into the following essential steps:
1. Initial Inventory Count
Businesses perform an initial inventory count to begin the inventory cycle, noting the quantity and cost of each item in store. It serves as the starting point for tracking changes.
2. Transaction Recording
All inventory-related activities, including purchases, sales, and returns, are recorded in a different account over the specified period rather than directly affecting the inventory balance.
3. Periodic Count
A physical count is performed after the inventory period. It entails physically counting the stock and figuring out the total value of the products based on their unit costs.
4. Calculation of Cost of Goods Sold (COGS)
The Cost of Goods Sold (COGS) is determined by subtracting the initial inventory balance from the final inventory count to determine the period’s COGS. The COGS is a key indicator of a company’s profitability.
5. Adjustments
The books are adjusted if there are any differences between the physical count and the recorded transactions. Theft, spoilage, and other inventory inconsistencies are considered with these modifications.
6. Financial Reporting
The final inventory balance is updated following the modifications, and the financial statements, including the income statement and balance sheet, are created using the new inventory statistics.
Benefits of a Periodic Inventory System
The periodic inventory method has several benefits that can immensely impact a business. We’ll examine the benefits of a periodic inventory system and understand how it contributes to inventory control optimization.
1. Cost-Efficient and Operational Simplicity
The periodic inventory system is built around a trademark of simplicity that indicates affordability. Under a periodic inventory system, inventory amounts are recorded on a typical monthly or yearly basis.
This simple method reduces the need for complicated, resource-intensive software and constant monitoring, which lowers operational costs. It makes the periodic inventory system formula especially appealing for medium and small-sized businesses looking to maximize income while minimizing administrative costs.
2. Technical Practicality and Accessibility
The periodic inventory method is an example of accessibility and practicality in a field where innovation often determines operational efficacy. Businesses can avoid the need for complex software installations and innovative technological infrastructure.
It benefits businesses located in locations with limited access to technology and new business owners filled with entrepreneurial energy. When companies get away from the constraints of strict technological requirements, they can put their efforts into innovation, marketing initiatives, and other crucial growth opportunities.
3. Reduced Risk of Errors and Data Integrity
The periodic inventory method of operation requires fewer data inputs, inherently lowering the possibility of errors. Businesses can keep the integrity of their inventory data and increase the accuracy of their decision-making processes by reducing the possibility of errors. This confidence in the accuracy of the data supports wise decisions and quick reactions to changing market conditions.
4. Streamlined Training and Organizational Agility
The periodic inventory system streamlines the training schedule and enhances organizational flexibility. This method’s simplicity speeds up onboarding new employees and temporary workers during busy times. The simplified training program supports operational continuity by assuring the seamless integration of individuals and processes, fostering a climate of long-term growth.
5. Financial Compliance and Audit Efficiency
Under a periodic inventory system, auditing achieves higher efficiency. Inventory audits that compare physical inventory counts with recorded values at specific intervals become more focused and organized. This targeted strategy improves conformity to financial requirements and results in real cost reductions, demonstrating how operational excellence and regulatory adherence coexist peacefully.
Interesting Read: Inventory Management: Importance and Benefits
Challenges of Periodic Inventory
Although the periodic inventory method is simple, it has its share of challenges that companies must overcome to maintain operational efficiency and profitability. We’ll now look at the drawbacks of periodic inventory management.
1. Inaccurate Inventory Levels
Periodic inventory management relies on intermittent physical counts, making it susceptible to inaccuracies in recorded inventory levels. Discrepancies can arise from theft, damage, and human error during counting. These errors can cause supply chain interruptions, overstocking, or stockouts, ultimately affecting customer satisfaction and revenue.
2. Disrupted Operations
Regular business operations must be stopped to conduct physical counts. Workflow and productivity can be affected by this disruption, particularly in companies with high inventory turnover rates or those engaged in seasonal demand changes. Order fulfillment delays, potential customer dissatisfaction, and revenue loss can result from operational disturbance.
3. Increased Carrying Costs
Overstocking can result from inaccurate inventory records, tying up valuable capital in extra inventory that may not be required. On the other hand, underestimating stock levels could lead to paying for expedited shipping to fill unexpected requests. Both possibilities result in higher carrying costs, which affect total profitability.
4. Difficulty Identifying Trends
Periodic inventory systems struggle to identify inventory trends like slow-moving or out-of-date items. This challenge makes managing inventory turnover, optimizing stock levels, and making informed decisions about certain products’ pricing, promotions, and discontinuation harder.
5. Lack of Data-Driven Insights
Periodic inventory methods cannot generate the data-driven insights necessary for strategic planning as they don’t have real-time data. Companies miss out on chances to improve the accuracy of demand forecasts and proactively change inventory strategy based on recent market developments and customer behaviors.
Suggested Read: Common Inventory Management Challenges and Practical Solutions
What Is a Perpetual Inventory System?
A perpetual inventory system is a complex method businesses use to maintain a real-time record of their inventory levels. Perpetual inventory systems offer continuous and automatic tracking of stock movements in contrast to periodic inventory systems, which occasionally require manual counts.
This streamlined method guarantees reliable and up-to-date data regarding the stock levels of products, assisting in efficient inventory management.
Every inventory movement in this system, including sales, purchases, returns, and adjustments, is immediately noted in the inventory management software. It gives organizations precise insights into stock levels, sales trends, and reorder points and instantly updates the inventory balance.
Due to this real-time information, businesses can make well-informed decisions about stock replenishment, pricing schemes, and demand forecasting.
Periodic vs. Perpetual Inventory Systems
The periodic inventory method is a traditional strategy that entails routine manual inventory counts to determine the amount of stock that is currently accessible. These counts are typically carried out at the end of a specific accounting period, such as a month or a year. This approach gives a broad picture of the entire inventory but lacks accurate real-time tracking.
On the other hand, the perpetual inventory system is a modern and automated technique that continuously updates inventory information in real-time. This system uses modern tools like barcode scanners, RFID tags, and specialized software to track every inventory movement, from receiving products to sales and returns. Businesses can accurately see their inventory levels at any time with this level of real-time tracking.
Businesses have the option to choose from perpetual and periodic inventory systems. Each approach has its advantages and drawbacks, catering to different business needs.
With our comparison of these two inventory systems, you can decide what suits your business the best!
| Key Differences | Periodic Inventory System | Perpetual Inventory System |
|---|---|---|
| Tracking Frequency | Inventory counts are conducted periodically, often at the end of an accounting period. | Inventory updates occur continuously, providing real-time insights into stock levels. |
| Accuracy | Inventory updates occur continuously, providing real-time insights into stock levels. | Offers high accuracy and minimizes discrepancies by immediately recording inventory movements. |
| Time and Effort | Requires significant time and effort during the counting process, disrupting operations. | Reduces the need for manual counting, saving time and streamlining operations. |
| Cost Efficiency | May lead to overstocking or stockouts, impacting operational costs and customer satisfaction. | Helps optimize inventory levels, reducing carrying costs and improving order fulfillment. |
| Technology Dependence | Relies on manual labor and may not require complex technology. | Requires investment in technology infrastructure, such as barcode scanners and inventory management software. |
Examples of Periodic Transaction Journal Entries
In a periodic system, businesses update their inventory balances at the end of a specific accounting period rather than after every transaction. This method streamlines the recording process, enabling improved inventory management and related financial activities.
You can record transactions in the accounting journal while using a periodic method. This journal displays the debits and credits for your business in a simple column format, organized by date.
Let’s explore examples of periodic transaction journal entries in this system.
1. Recording Inventory Purchases
The “Purchases” account is debited when inventory is bought on credit, and the “Accounts Payable” account is credited in the journal entry. It captures the increase in the inventory account and the corresponding liability for the amount owed.
2. Accounting for Purchase Discounts
In case of early payment or purchase discounts, the journal entry debits the “Accounts Payable” account and credits the “Purchase Discount” account, reflecting the reduced amount owed.
3. Recording Total Payables and Discounts
Combining the accounts payable and purchase discount entries, this journal entry debits the “Accounts Payable” account and credits the “Purchase Discount” account, reflecting the net payable amount.
4. Handling Purchase Returns
When inventory is returned, the journal entry debits either the “Accounts Payable” or “Accounts Receivable” account (depending on the transaction) and credits the “Purchase Returns” account.
5. Recording Inventory Sales
When inventory is sold on credit, the journal entry involves crediting the “Accounts Receivable” account and crediting the “Sales” account.
6. Accounting for Sales Discounts
If a sales discount is offered, the journal entry debits the “Sales Discount” account and credits the “Accounts Receivable” account, reflecting the reduction in revenue
7. Recording Total Discounts
By combining inventory sales and sales discount entries, this journal entry captures the total discount offered to customers.
8. Handling Sales Returns
Similar to purchase returns, when customers return inventory, the journal entry debits the “Sales Returns” account and credits either the “Accounts Receivable” or “Accounts Payable” account (depending on the original transaction).
9. Completing the Closing Entry
After a physical inventory count, a closing entry is made at the end of the accounting period. This entry involves debiting the “Ending Inventory” and “Cost of Goods Sold (COGS)” accounts and crediting the “Beginning Inventory” and “Purchases” accounts. The difference represents the calculated COGS for the period.
Does Your Business Need A Periodic Inventory System?
The periodic inventory system offers an easy-to-use and economical method of managing inventories, ideal for small enterprises or those with limited resources. By intermittently updating inventory records rather than in real-time, companies can streamline their operational processes and reduce the administrative burden of continuous monitoring.
However, it’s important to acknowledge that the periodic inventory system has drawbacks. A lack of real-time data may make inventory levels inaccurate, resulting in stockouts or overstock conditions.
Missed sales opportunities or higher carrying expenses could result from this. Additionally, the system may not be appropriate for companies that deal with high-value or perishable goods, where accurate inventory control is essential.
While the periodic inventory system might not offer the real-time precision of its perpetual counterpart, its simplicity, reduced resource requirements, and potential cost savings make it a viable option for certain businesses.
Yes, a business can switch from periodic to perpetual inventory by implementing an automated tracking system that monitors stock levels and updates in real time, improving accuracy and efficiency.
Smaller companies with fewer items and resources benefit from a periodic inventory system. It occasionally does manual counts for simpler processes that don't require constant tracking.
Periodic inventory involves occasional physical stock counts to update inventory records, while perpetual inventory uses real-time tracking systems for continuous monitoring, offering more accurate and efficient inventory management.
Priya is a seasoned writer with expertise in the SaaS industry. With over five years of experience in the field, she deeply understands the requirement of this specific industry, its techniques, and tools. Her articles, whitepapers, and blog posts are known for their clarity, practicality, and actionable insights. Priya also possesses in-depth knowledge of SEO and content marketing, which enables her to develop effective strategies to increase website traffic and improve brand visibility.
