A successful business cannot exist without efficient inventory management. As your organization scales, it becomes difficult to manage inventory. You cannot rely on historical data or traditional methods to keep up with the dynamic demands of customers. In today’s world, organizations must have a system to track inventory continuously and in real-time. Thanks to the perpetual inventory system, entrepreneurs can monitor, update & track their inventory in real-time.
This blog will help you understand the definition of perpetual inventory, its methods & formula to calculate perpetual stock & how the perpetual stock system works. Let’s get started.
What is Perpetual Inventory?
Perpetual inventory is a continuous accounting method where inventory levels are updated constantly as items are bought and sold. It automatically adjusts stock levels after every sale or purchase. The essence of perpetual inventory relies on specialized software or point-of-sale (POS) systems that track each item’s movement.
Due to accurate inventory forecasts, businesses are able to serve their customers better, leading to brand loyalty, customer trust & increased retention rates.
Features of Perpetual Inventory
This section of the blog explores the characteristics of Perpetual Stock System
- Live Inventory Updates: Every inventory transaction, from sales to returns to new stock additions, is immediately recorded. This real-time approach provides managers with instant visibility into stock levels, aiding in precise decision-making and reducing the risk of stockouts or overstocking.
- Accurate Inventory Forecast: By consistently updating inventory levels after each transaction, perpetual inventory minimizes errors that can occur with periodic systems reliant on occasional manual counts.
- Automated Inventory Management: Perpetual inventory control automates repetitive processes like generating purchase orders when inventory dips below a predefined threshold. This frees up your staff to focus on higher-value activities like customer service and strategic planning.
- Cost Monitoring: The perpetual system facilitates accurate calculation of the Cost of Goods Sold (COGS) by continuously adjusting for the costs of items sold or used in production. This real-time COGS calculation helps in evaluating profitability and maintaining financial transparency.
- Integration: Modern perpetual inventory systems are often integrated with other business systems like accountancy software and point-of-sale (POS) systems. This integration streamlines operations by automatically updating financial records and providing comprehensive insights into inventory-related costs and revenues.
Periodic vs Perpetual Inventory: Key Differences
| Basis | Periodic Inventory | Perpetual Inventory |
|---|---|---|
| Definition | Also known as a physical inventory system, it is a manual method for determining the value of on-hand inventory at specific points in time. | Perpetual inventory is an advanced & automated method of tracking inventory where updates to inventory records occur in real-time, reflecting every transaction—whether it's a sale, purchase, return, or adjustment. |
| Inventory Tracking Timeline | Periodic (e.g., monthly, annually) | Continuous ( eg: after each sale or purchase) |
| Accuracy | Less accurate due to less frequent counts | More accurate due to real-time data |
| Stockouts | Higher risks of stockout | Lower risk of stockouts |
| Cost of Setup | Lower Initial Cost | Higher initial cost of setup due to technological integrations |
Methods & Formula in Perpetual Inventory System
Depending on the method, the formula also varies. Listed below are popular Perpetual Inventory Methods & their calculation formula:
- FIFO Perpetual Inventory Method(First-In-First-Out): This method assumes that the oldest inventory items are sold first. The items purchased first are the first-ones sold.
- Formula (FIFO COGS): Beginning Inventory (at FIFO cost) + Purchases (at FIFO cost) – Ending Inventory (at FIFO cost)
- LIFO Perpetual Stock Method (Last-In-First-Out): This method is in stark contrast to FIFO. Unlike FIFO, LIFO calculates closing goods on the assumption that the most recently acquired inventory items are sold first. This method might be used for products such as electronics, where the newest models are typically sold first, or fast-fashion brands where latest styles are in trends.
- Formula (LIFO COGS): Beginning Inventory (at LIFO cost) + Purchases (at LIFO cost) – Ending Inventory (at LIFO cost)
- Weighted Average Cost: This method calculates the average cost of inventory items after each purchase. The WeighteIt is beneficial in industries where prices fluctuate frequently, such as in the oil and gas sector.
- Formula (Average Cost COGS): (Beginning Inventory + Purchases) / (Units Sold + Ending Inventory) * Units Sold
Pros & Cons of Perpetual Inventory System
Listed below are the advantages and disadvantages of Perpetual Inventory System
Advantages of Perpetual Stock Control
- Better Decision-Making: Using up-to-date inventory information helps to optimize stock levels, reduce carrying costs, and improve customer satisfaction through reliable product availability.
- Higher Customer Satisfaction: Perpetual Inventory Control is characterized by reduced stockouts and improved customer service. This in turn leads to higher customer satisfaction.
- Efficient Inventory Management: By eliminating the need for frequent physical counts, and the errors due to manual periodic inventory calculation, perpetual inventory systems save time and labor costs associated with inventory management.
Disadvantages of Perpetual Stock Control
- High Investment: The setup of perpetual inventory systems is expensive as it is governed by various technological integrations and hardware installations.
- Learning Curve: Due to continuous updates & higher maintenance, perpetual stock systems can lead to a learning curve among entrepreneurs as they learn how to navigate the challenges.
- Dependent on Technology: Perpetual Inventory is highly reliant on technology and connectivity. This translates to businesses must have backup plans in place to handle potential system failures or disruptions.
When should you use Perpetual Inventory System
Listed below are the ideal scenarios, where using a perpetual stock system can be beneficial for organizations. Unlike low-volume businesses, perpetual inventory systems are particularly beneficial for high-volume businesses operating in dynamic industries with fast-moving goods, such as retail, manufacturing, and distribution.
- High-Volume Sales & Fast-Moving Inventory: Shelves are constantly restocked as customers keep buying products. A perpetual system tracks every sale, ensuring accurate stock levels. This prevents stockouts and missed sales opportunities, especially for fast-selling items.
- High Accuracy is Crucial: Industries requiring precise inventory data for regulatory compliance, financial reporting, or operational efficiency benefit greatly from perpetual systems.
- Real-time Reporting is necessary: For timely decision-making, especially in responding to customer demand fluctuations or optimizing inventory turnover rates, perpetual inventory systems provide critical insights.
- Expensive Items: Perpetual systems with real-time data can identify discrepancies quickly, potentially catching theft attempts or shrinkage (inventory loss due to damage or waste) before they become significant issues. This allows for tighter security measures and improved inventory management.
Bottom Line
Perpetual inventory offers an effective way to gain real-time control over stock. The advent of the perpetual inventory system represents a significant advancement over periodic methods, offering improved accuracy and operational efficiency. Businesses can leverage real-time data insights, to gain a competitive edge in managing their inventory effectively and meeting customer expectations consistently.
