Periodic Inventory System: How It Works, Benefits, and Example
The periodic inventory system is a great solution for many small businesses. Learn how it works, understand its benefits, and see an example.
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Are you a small business owner who’s tired of grappling with inventory management?
Perhaps you’ve been on the hunt for a simple yet effective solution.
The periodic inventory system could be a game-changer.
In this article, we’ll take a deep dive into the world of the periodic inventory system, covering its many benefits and walking you through a practical example to give you a clear understanding of how it works.
So, buckle up and get ready to revolutionize the way you manage your inventory. This might just be the missing piece to help your business run like a well-oiled machine.
- The periodic inventory system is a simple and cost-effective method for small businesses to manage inventory.
- This system doesn’t need expensive software and can be easy to implement.
- A periodic inventory system helps businesses periodically calculate the cost of goods sold (COGS).
What is a periodic inventory system?
The periodic inventory system is an accounting method that helps your business track inventory levels over a specific accounting period.
Unlike the perpetual inventory method, which updates inventory records in real time, the periodic system updates records at the end of an accounting period (typically on a monthly or annual basis).
This approach is particularly well-suited to small businesses, as it doesn’t need expensive computerized systems or point-of-sale (POS) equipment (like barcode scanners).
How does the periodic inventory system work?
In the periodic inventory system, you start by recording your beginning inventory.
You record any purchases made throughout the period but don’t update inventory levels for sales.
You do a physical inventory count at the end of the period and compare it to the beginning inventory to determine the cost of goods sold (COGS).
How to calculate COGS using the periodic inventory system
Follow these steps to calculate COGS using the periodic inventory system:
- Determine the beginning inventory value.
- Add the value of all inventory purchases made during the period.
- Conduct a physical count of the ending inventory value.
- Subtract the ending inventory value from the sum of the beginning inventory and purchases.
COGS = Beginning Inventory + Purchases - Ending Inventory
An example of the periodic inventory system
Imagine a small bookstore that uses the periodic inventory system.
It has $10,000 worth of inventory at the beginning of the month.
The bookstore purchases an additional $5,000 worth of books throughout the month.
At the end of the month, the store does a physical count of inventory and finds it has $7,000 worth of inventory remaining.
The COGS for the month goes like this:
COGS = $10,000 (Beginning Inventory) + $5,000 (Purchases) - $7,000 (Ending Inventory) = $8,000
What are the differences between perpetual and periodic inventory systems?
A perpetual inventory system is a method of managing and tracking inventory in real time.
It continuously updates inventory records to account for purchases, sales, and other inventory-related transactions.
This system involves inventory management software, which gives up-to-date and accurate data on inventory levels and the cost of goods sold (COGS).
The main differences between perpetual and periodic inventory systems are:
- Perpetual inventory systems continuously update inventory records, while periodic systems update them periodically (typically at the end of the accounting period).
- Perpetual systems usually involve inventory management software, while periodic systems don’t. This makes them simpler and less expensive.
- Perpetual systems offer real-time inventory data, while periodic systems offer inventory data at the end of each period. This can result in discrepancies between actual and recorded inventory levels.
- Perpetual systems can be more accurate due to continuous updates, while periodic systems may have inaccuracies due to manual record-keeping and potential human error.
- Perpetual systems are more suitable for businesses with high inventory turnover or complex inventory systems, while periodic systems are better suited for small businesses with lower inventory turnover.
Besides the differences we’ve talked about, how you value your inventory — like using First-In, First-Out (FIFO) or Last-In, First-Out (LIFO) — can also affect how each system works.
FIFO means you sell the oldest items in your inventory first, while LIFO means you sell the newest items first.
You can apply both methods to perpetual or periodic inventory systems, but they might give different results for your ending inventory balance and the cost of goods sold, depending on how your inventory moves and if prices change.
Just remember that the way you value your inventory should follow generally accepted accounting principles (GAAP).
In the end, picking between a perpetual and periodic inventory system — and the right inventory valuation method — really depends on what works best for your specific business and resources.
What are the benefits of using a periodic inventory system?
The periodic inventory system offers several benefits, including:
Good for small businesses
The periodic inventory system is particularly well-suited if you own a small business that maintains minimal inventory.
The smaller scale of operations lets you complete a physical inventory item count and estimate the cost of goods sold for specific periods.
This approach offers better inventory control, allowing you to manage inventory costs efficiently.
Don’t need expensive software
One of the key advantages of the periodic inventory system is that you don’t need to invest in expensive software or complex accounting systems.
Instead, this cost method relies on simpler record-keeping methods — which can help you reduce the total cost of inventory management by eliminating an additional software cost.
In contrast, perpetual inventory systems often involve the use of sophisticated software and technology to track inventory in real time.
While these systems can offer more accurate and updated inventory data, they also come with higher costs — as you’ll need to invest in hardware, software, and employee training.
Some popular perpetual inventory management systems include NetSuite and Fishbowl Inventory.
However, it’s important to weigh the benefits of both systems carefully.
While the periodic system can be more cost-effective, the perpetual system can offer more precise inventory data and financial statements.
You’ll know the amount of inventory without completing the time-consuming task of counting physical inventory periodically.
The perpetual system can also help streamline different accounting tasks, like updating your general ledger, managing accounts receivable, and giving you a more accurate inventory valuation.
Easy to implement
The periodic inventory system is known for its ease of implementation.
Since it involves fewer records and simpler calculations than the perpetual system, you can set it up with minimal effort and resources.
On the plus side, this means you don’t necessarily need to rely on complex software or technology to maintain inventory accounts.
Instead, you can keep track of inventory purchases and sales using traditional journal entries, updating the inventory account only at the end of each accounting period.
However, the simplicity of the periodic system allows for manual record-keeping, which can be prone to errors.
And miscounting items or transposing numbers can lead to inaccuracies in the inventory records.
These inaccuracies can have a domino effect, impacting your balance sheet and other financial statements and affecting your business’s overall financial health.
But the periodic inventory system can still be a good option if your small business has limited resources and straightforward inventory needs.
What is the periodic inventory system good for?
The periodic inventory system can be a good fit for:
- Small businesses with limited resources and budgets. The periodic inventory system can be cost-effective for smaller businesses that don’t have the resources to invest in expensive inventory management software or dedicated inventory management staff.
- Businesses with low inventory turnover or simple inventory management needs. Companies that don’t have a high volume of inventory turnover or that deal with a limited range of inventory items can benefit from the simplicity of the periodic inventory system.
- Businesses that prefer a cost-effective and easy-to-implement inventory management system. The periodic inventory system is relatively easy to set up and maintain, making it an attractive option for businesses looking for a straightforward approach to inventory management.
- Companies that don’t need real-time inventory tracking or updated inventory data for decision-making. The periodic inventory system might be enough for businesses that can afford to wait until the end of the accounting period for inventory data.
- Businesses that need to simplify their income statement. The periodic inventory system can help streamline the income statement since it only needs the COGS calculation at the end of the accounting period (rather than continuously updating inventory values like with a perpetual system).
Here are some businesses and the type of inventory that can benefit from a periodic inventory system:
- Local bakery. A small bakery sells a limited range of freshly baked goods, such as bread, cakes, and pastries. Their inventory turnover is relatively low, and they can easily perform a physical count of the remaining ingredients and raw materials at the end of each accounting period.
- Independent bookstore. A small bookstore that offers a modest selection of books and stationery items. They don’t have high inventory turnover, and their inventory management needs are relatively simple.
- Handmade jewelry store. A boutique store selling handcrafted jewelry made by the owner or local artisans. The inventory levels are manageable, and the inventory turnover rate isn’t particularly high.
- Small art gallery. A gallery selling original artwork and limited edition prints by local artists. The inventory consists of a small number of unique items that don’t need constant monitoring and real-time tracking.
- Home-based clothing business. A home-based business selling handmade or custom-designed clothing items has limited inventory, making it easy to manage and track using the periodic inventory system.
Businesses that can benefit from a perpetual inventory system include:
- Large supermarket. A large supermarket has a big range of products, high inventory turnover, and complex inventory management needs. They need real-time inventory tracking to maintain adequate stock levels and prevent stockouts or backorders.
- Electronics store. An electronics store sells various gadgets, devices, and accessories. They deal with a high volume of inventory and need accurate, real-time inventory data to manage their stock effectively.
- ECommerce business. An online business sells and ships products directly to customers. They have a high inventory turnover rate and need a perpetual inventory system to manage their stock levels and shipping processes.
- Automotive parts store. A store sells various automotive parts and accessories. Due to the diverse range of products and the need for accurate tracking of inventory levels, a perpetual inventory system might be more suitable.
- Pharmaceutical company. A company deals with a large inventory of medications, vaccines, and other medical supplies. They need precise, real-time inventory tracking to manage stock levels and expiration dates and maintain compliance.
Managing your own deliveries? Circuit for Teams can help
We’ve been chatting about periodic and perpetual inventory systems, and it’s obvious that keeping your inventory in check is super important.
But what about when your inventory is out there on the road, heading to your customers?
If your business relies on managing its own deliveries, drivers, and routes, finding a solution that streamlines this process and maximizes efficiency is essential.
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