Perpetual Inventory System
A perpetual inventory system tracks inventory levels in real-time by continuously updating records of all inventory transactions, ensuring that inventory is always at an optimal level.
Under a perpetual inventory system, inventory records are updated every time a product is received or sold, allowing companies to have an up-to-date view of their inventory levels at any given time. This system generally uses a computerised tracking system to automate the process of updating inventory records, reducing the likelihood of errors or discrepancies. The perpetual inventory system allows companies to easily assess and address inventory shortages, overstocking, and other issues that may impact their bottom line.
Formulas in Perpetual Inventory
Under the perpetual inventory system, various formulas are used to calculate inventory values, reorder points, and other inventory-related metrics. The Economic Order Quantity (EOQ) and the Cost of Goods Sold (COGS) formulas are important.
Economic Order Quantity (EOQ)
The EOQ formula is used to determine the optimal order quantity for inventory products. For this formula, the cost of ordering inventory, the cost of holding inventory, and the demand for the product are considered. The EOQ formula is as follows:
EOQ = 2DS/H
where:
D = annual demand for the item
S = ordering cost per order,
H = holding cost per unit per year
Using this formula, businesses can reduce inventory carrying costs while ensuring they maintain enough inventory to meet customer demand. By determining the optimal order quantity, businesses minimise the frequency of ordering and the costs associated with holding excess inventory.
Cost of Goods Sold (COGS)
The COGS formula is used to calculate the cost of goods sold during a specific period. For this formula, the cost of beginning inventory, the cost of inventory purchases, and the cost of ending inventory are considered. The COGS formula is as follows:
COGS = Beginning Inventory + Purchases – Ending Inventory
This formula is essential for businesses to help them track the cost of goods sold and determine the gross profit margin. By monitoring the COGS over time, businesses can easily identify trends and make informed decisions about pricing, inventory management, and other areas of the business.
Methods Under Perpetual Inventory
There are several methods used under perpetual inventory, including:
First In, First Out (FIFO): Under this method, it is assumed that the first items added to inventory are the first ones sold. In other words, the oldest inventory products are sold first. This method is used in industries with perishable goods or expired products.
Last In, First Out (LIFO): Under this method, the most recent products added to the inventory are sold first. This method is often used in industries with non-perishable goods or where inventory costs tend to rise over time.
Weighted Average Cost: Under this method, the average cost of all units of inventory in stock is calculated. The total cost of all units is divided by the total number of units to determine the average cost per unit.
Specific Identification: This method tracks each individual item of inventory and assigns a specific cost to each item. It is often used for high-value items or items with unique characteristics.
Standard Costing: This method assigns a predetermined cost to each unit of inventory based on the company’s standard cost system. The standard cost is based on estimating materials, labour, and overhead costs.
Retail Inventory Method: This method is often used in the retail industry. It involves estimating the inventory cost based on the cost ratio to the retail price. This method is useful for companies with high sales volume and a wide range of products.
What is a Perpetual Inventory System?
A perpetual inventory system is a method of inventory management that includes tracking inventory levels in real-time. It provides a continuous record of inventory transactions, including sales, purchases, and returns. The system automatically updates inventory levels automatically using technology, such as barcode scanners and POS systems.
How Does the Perpetual Inventory System work?
In a perpetual inventory system, each item in inventory is assigned a unique identifier, such as a barcode or serial number. When an item is sold, the system updates the inventory level and records the sale. The system updates the inventory level and records the purchase when new inventory is received. This gives businesses real-time information on inventory levels, which helps them make informed decisions about purchasing, pricing, and inventory management.
The following processes take place under a perpetual inventory system:
- Inventory levels are updated automatically by the point-of-sale system.
- The cost of goods sold (COGS) is recalculated automatically.
- Reorder points are adjusted to maintain optimal inventory levels.
- Purchase orders are generated and sent to suppliers.
- Products are scanned into the inventory system.
Perpetual inventory systems have several advantages over other inventory management methods. They provide accurate and up-to-date information on inventory levels, which helps businesses avoid stockouts and overstocking. They also allow businesses to track inventory movements and identify trends in sales and purchasing.
However, perpetual inventory systems also require significant investment in technology and training. They also require ongoing maintenance to ensure the accuracy of inventory records. Despite these challenges, many businesses choose to use perpetual inventory systems because of their accuracy and efficiency benefits.
What Distinguishes a Perpetual Inventory System from a Periodic Inventory System?
Perpetual inventory and periodic inventory systems are two different methods of inventory management. Here’s how they differ:
Perpetual inventory system is a method of inventory management that involves continuous and real-time tracking of inventory levels. Each item in inventory is assigned a unique identifier, such as a barcode or serial number. When an item is sold, the system automatically updates the inventory level and records the sale. The system updates the inventory level and records the purchase when new inventory is received. This gives businesses real-time information on inventory levels, which helps them make informed decisions about purchasing, pricing, and inventory management.
Whereas a periodic inventory system is a method of inventory management that involves tracking inventory levels at specific intervals, such as monthly or quarterly. At the end of each period, a physical inventory count is taken, and the cost of goods sold (COGS) is calculated based on the beginning, purchase, and ending inventory. This method requires businesses to count inventory and record inventory transactions during the period manually.
Below are a few aspects that mark the difference between the two methods:
Account Updates:
Under the perpetual inventory system, inventory levels are continuously and automatically updated as soon as a transaction is made. The system provides real-time information on inventory levels, which helps businesses make informed decisions about purchasing, pricing, and inventory management. Whereas under a periodic inventory system, the inventory levels are updated only at the end of each accounting period.
COGS Calculations:
In a perpetual inventory system, the cost of goods sold (COGS) is automatically calculated based on the inventory level and the cost of each item. While a periodic inventory system calculates COGS only at the end of each accounting period based on a physical count of inventory.
Transaction Records:
In a perpetual inventory system, all inventory transactions, including sales, purchases, and returns, are automatically recorded in real-time. Businesses have access to a continuous and accurate record of inventory transactions. In contrast, a periodic inventory system requires manual recording of inventory transactions during the accounting period and a physical count of inventory at the end of the period.
Cycle Counting:
The perpetual inventory system uses cycle counting to verify inventory levels and identify discrepancies periodically. This helps in identifying and addressing inventory discrepancies in real time. On the other hand, a periodic inventory system relies on a physical inventory count at the end of the accounting period to identify discrepancies.
Recording Purchases:
A perpetual inventory system records purchases automatically as soon as they are received as inventory. With this, businesses can access real-time information on inventory levels and make informed purchasing decisions. The periodic inventory system requires manual recording of inventory purchases during the accounting period and a physical count of inventory at the end of the period.
Who Should Use the Perpetual Inventory System?
Perpetual inventory system is ideal for businesses with high inventory turnover and requires accurate and real-time information on inventory levels. These include
Retail Businesses: Retail businesses, such as grocery stores, clothing stores, and electronics stores, require accurate and up-to-date information on inventory levels to meet customer requirements and manage their supply chain effectively.
Manufacturing Businesses: Manufacturing businesses require accurate and timely information on raw materials and finished goods inventory levels to ensure smooth production and avoid stockouts.
E-commerce Businesses: E-commerce businesses require real-time information on inventory levels to manage their online storefronts effectively and meet customer demands promptly.
Businesses with Multiple Locations: Businesses with multiple locations require accurate and up-to-date information on inventory levels across all locations to ensure that they can fulfil orders from any location.
Businesses with High-value Inventory: Businesses with high-value inventory, such as jewellery stores and art galleries, require accurate and real-time information on inventory levels to manage inventory losses, prevent theft, and maintain security.
Advantages of Perpetual inventory system
The perpetual inventory system is a highly advanced and accurate system for tracking and monitoring inventory in real-time, making it an advantageous solution for all businesses. Here are some of the key benefits of using a perpetual inventory system:
Accurate and Real-Time Data Recording:
With the perpetual inventory system, businesses may no longer worry about outdated or inaccurate data as the information is updated in real-time. This ensures that the inventory levels are always up-to-date and accurately recorded, providing a clearer view of stock levels at all times.
Identifying Bottlenecks:
The perpetual inventory system allows for monitoring stock movements and interactions throughout the supply chain. This gives businesses valuable insights into their processes and helps identify any bottlenecks hindering productivity or efficiency.
Reduced Inventory Management Costs:
The perpetual inventory system can automatically calculate stock holding costs, replenish low stock items, and eliminate the need for manual stock counts, thus saving labour costs.
Consistent Stock Levels:
The system enables businesses to investigate stock level discrepancies and make necessary stock adjustments. It is easy to run spot checks to detect theft, damage, or errors and quickly adjust figures as needed.
Demand Forecasting:
Using a perpetual inventory system makes demand forecasting easier and more accurate. The continuous inventory system streamlines forecasting by analysing past stock levels and sales data to predict future market patterns and cycles. This ensures that businesses are prepared with sufficient stock levels during specific periods of high demand, such as the holiday season. By accurately predicting demand and adjusting inventory levels accordingly, businesses can avoid stockouts, minimise inventory costs, and maintain customer satisfaction.
Conclusion
A perpetual inventory system is essential for businesses looking to streamline their inventory management processes. This system provides real-time visibility into inventory levels, automates transactions, and enables businesses to make data-driven decisions. With this, businesses can improve their accuracy, reduce costs, optimise their supply chain, and ultimately enhance their bottom line.
