Periodic and perpetual inventory systems are two contrasting accounting methods that businesses use to track the quantity of products they have available.
What Is Periodic Inventory?
The periodic system uses an occasional physical count to measure the level of inventory and the cost of goods sold (COGS). Merchandise purchases are recorded in the purchases account. The inventory account and the cost of goods sold account are updated at the end of a set period – this could be once a month, once a quarter, or once a year. Cost of goods sold is an important accounting metric, which when subtracted from revenue, shows a company's gross margin.
Cost of goods sold under the periodic inventory system is calculated as follows:
Beginning Balance of Inventory + Cost of Inventory Purchases - Cost of Ending Inventory = Cost of Goods Sold
Since businesses often carry products in the thousands, performing a physical count can be difficult and time-consuming. Imagine owning an office supply store and trying to count and record every ballpoint pen in stock. Now multiply that for an office supply chain. For these reasons, many companies perform a physical count only once a quarter or even once a year. For companies under a periodic system, this means that the inventory account and cost of goods sold figures are not necessarily very fresh or accurate.
What Is Perpetual Inventory?
In contrast, the perpetual system keeps track of inventory balances continuously, with updates made automatically whenever a product is received or sold. Purchases and returns are immediately recorded in the inventory account. As long as there is no theft or damage, the inventory account balance should be accurate. The cost of goods sold account is also updated continuously as each sale is made. Perpetual inventory systems use digital technology to track inventory in real time using updates sent electronically to central databases.
For example, at a grocery store using the perpetual inventory system, when products with barcodes are swiped and paid for, the system automatically updates inventory levels in a database.
Which System Is Better?
Periodic inventory accounting systems are normally better suited to small businesses due to the expense of acquiring the technology and staff to support a perpetual system. A business such as a car dealership or art gallery might be better suited to the periodic system due to the low sales volume and the relative ease of tracking inventory manually. However, the lack of accurate information about the cost of goods sold or inventory balances during the periods when there has been no recent physical inventory count could hinder business decisions.
Businesses with high sales volume and multiple retail outlets (like grocery stores or pharmacies) need perpetual inventory systems. The technological aspect of the perpetual inventory system has many advantages such as the ability to more easily identify inventory-related errors. The perpetual system can show all transactions comprehensively at the individual unit level. Under the perpetual system, managers are able to make the appropriate timing of purchases with a clear knowledge of the quantity of goods on hand at various locations. Having more accurate tracking of inventory levels also provides a better way of monitoring problems such as theft.
The Bottom Line
Overall, the perpetual inventory system offers many benefits over the periodic system and is now used by all major retailers. However, a small business owner must still take into account whether the benefits of installing a perpetual inventory system will outweigh the additional expense.