What is a perpetual inventory system?
By: Aaron Rubin, Founder & CEO of ShipHero
Physical inventory counts are an extreme time sink. Employees have to walk around and manually count inventory levels to double-check inventory records. Not only are these physical counts a time-consuming way to track inventory, but they can also be inaccurate due to human error.
Periodic inventory systems that use this manual inventory management system are slowly phasing out to be replaced by more up-to-date processes that are less prone to error. Modern inventory systems save time for employees, so they don’t have to count items in storage bins when they have more vital work to do.
A system that has gained popularity as technology has advanced is called perpetual inventory accounting. Perpetual systems are technology-driven solutions that allow for your different software platforms to share information with each other. Companies that take advantage of this new, interconnected system can benefit from things like real-time data, point of sale (POS) integration, more accurate inventory balances, and significant amounts of saved time for employees.
Perpetual inventory systems work by tracking inventory directly through your point of sale software and inventory management software. By leveraging things such as barcode scanners and transaction data, the system automatically tracks stock and inventory items as they are acquired in the warehouse or sold. You can still hold inventory counts, but only to account for potential damages to inventory or theft, not to track your entire inventory system.
Advantages of a perpetual inventory system
There are a handful of excellent advantages to a perpetual system. Due to its automatic nature, as soon as the merchandise is sold or acquired, your COGS account (Cost of Goods Sold) is immediately updated. Through real-time database updates, accounts payable and accounts receivable can instantly and accurately report and analyze inventory and sale data. Perpetual systems also leave a paper trail for all received shipments and purchases, helping with audits and fraud prevention.
Manual counting of inventory numbers isn’t used in perpetual systems to the same extent as other systems. Implementing a perpetual sale system that automatically sends inventory data to a central database saves your employees time and your company money. Automatic systems also cut out human error, saving you money on poorly managed and miscounted inventory.
Disadvantages of a perpetual inventory system
The barrier to entry for perpetual inventory systems is their initial cost. Purchasing all the needed items such as the perpetual inventory software, RFID or barcode scanners, and other additional hardware has a high average cost for companies.
Costs for training are also a consideration when considering the initial investment into a new perpetual system. While you can recoup initial costs in the form of wage savings and inventory management savings, the initial investment may still be too much to justify depending on your stock turnover and inventory.
What is the FIFO perpetual inventory method?
First-in, first-out (FIFO) processes act as if the first item you received will be the first item sold. In FIFO perpetual methods, the FIFO standards are assumed within the software, indicating that the most recent costs of purchased merchandise are the first to be charged against revenue. Perpetual FIFO is extremely common and often reflects the proper flow of goods through a company.
What is the LIFO perpetual inventory method?
Last-in, first-out (LIFO) processes assume that the last unit you receive will be the first unit that you sell. Opposite the FIFO method, the last cost of merchandise is what you charge against your company’s revenue. Often this method is used for specific accounting purposes, such as tax breaks.
How does a perpetual inventory system differ from a periodic system?
Unlike the automatically driven perpetual systems, periodic systems rely on occasional physical inventory counts to keep track of stock and COGS. Periodic systems require significantly more manual involvement in inventory tracking and data updates. There are a few key advantages to consider for automatic perpetual systems:
Keep up with data in real-time
Perpetual systems use technology to update inventory data immediately as items are sold and transferred. Instant inventory updates mean that your teams can perform up-to-date analytics at any time while having faith that their inventory numbers are close to accurate. Real-time updates also empower your team to create more consistent, accurate reporting to keep an eye on product and sales performance.
Leave a paper trail
Due to tracking all inventory movements through digital software, you leave a reliable trail of data. Paper trails allow for easier audit compliance, fraud detection, and more accurate insights. Tracking can also help you get an overall view of your supply chain, helping you find areas where you can improve your practices.
Lower inventory management costs
Perpetual systems are a considerable investment upfront; however, they will lead to lower inventory management costs over time. Manual systems such as inventory counting are needed significantly less often or not at all. Real-time analytics means that you can prevent things like holding costs as well, saving you money.
Easily investigate stock level discrepancies
Since perpetual systems are constantly updating, you can more quickly see discrepancies in stock data. You can detect things like theft, damaged goods, and fraud through missing stock and inventory. Finding stock discrepancies faster can help give insight into issues that may become much larger if left unhandled, such as store security issues.
Leverage demand forecasting to grow your business
Keeping accurate and up-to-date stock information helps you forecast demand. Through reliable analytics and historically tracked inventory data, you can detect trends in your demand and make changes to your purchasing practices accordingly. Preventing running out of inventory during high-demand seasons like the holidays can help your company’s profits significantly.
When to use a perpetual inventory system
Not all companies require a fully-fledged perpetual inventory system, especially if they have small amounts of stock with little variety. There are specific places in which perpetual inventory systems do shine, including businesses with high inventory turnover or quickly growing companies.
Your business is growing rapidly
When your business is growing very quickly, implementing a perpetual inventory system can help track your new and growing stock. By implementing a perpetual system as things start growing for your company, you can keep a paper trail to track and project continued growth. Deciding to add a perpetual system set up to your company sooner rather than later can also mean saving future training and rollover costs.
You have dozens of SKUs
Dozens and dozens of SKUs are hard to track, especially when you have to go through and correctly note them manually. More SKUs mean more potential for human error and longer hours to try and track inventory data. Perpetual systems don’t struggle no matter how many SKUs you have, making them a great option if you have a large inventory variety. For example, grocery stores almost always use perpetual systems to track all of their various products.
Inventory turnover is high
Slow, manual counts don’t often cut it for analytics and tracking when your company has exceptionally high inventory turnover. It is harder to track trends and demand when your inventory moves quickly, so a real-time system is crucial for accurate data collection.
When stock is turning over fast in your company, it also can lead to lost inventory. A perpetual system helps keep precise data tracking and prevents things like theft.
Formulas in perpetual inventory
There are a few crucial formulas used within perpetual inventory systems. Cost of goods sold (COGS) and gross profit formulas help make sense of your data and give your company data for future business decisions.
The Cost of Goods Sold (COGS)
You can calculate the cost of goods sold (COGS) first by adding your beginning purchases and inventory, which is the cost of goods available for sale. Next, you will find the ending inventory and subtract that from your initial numbers. These numbers are tracked easily and automatically in a perpetual inventory, which means you can pull a continually updated COGS report.
Beginning Inventory + Purchases – Ending inventory = COGS
The gross profit is your actual profits after subtracting how much your operating expenses cost you during a period. To find this number, all you have to do is subtract your COGS from your total revenue.
Revenue – COGS = Gross Profit
Perpetual inventory systems can be an investment to implement, but they have many strengths over periodic systems. While periodic inventory systems can be suitable for companies with lower turnover or less product variety, perpetual inventory systems can provide significant advantages to companies that make many sales or have a broader range of product lines.
Manual tracking used in period systems takes time and is prone to human error. Perpetual systems track your inventory data in real-time, allowing your team to make faster reports, more accurate analytics, and save time in manual counting by leveraging technology. While the initial investment may seem daunting, the long-term profits seen from saved money in areas like inventory management make perpetual systems an excellent move for many growing companies.
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Aaron Rubin, Founder & CEO
About the author: Aaron Rubin is the Founder & CEO of ShipHero. He is responsible for planning and executing the overall vision and strategy of the organization. Rubin’s greatest strengths are leadership, change management, strategic planning and a passion for progression. He is known for having his finger on the pulse of ShipHero’s major initiatives, his entrepreneurial spirit, and keen business acumen. His leadership of ShipHero is grounded in providing excellent customer service that drives improved business operations. His passion for ShipHero comes from the culture and his ability to have an impact on the lives of employees, customers, partners, and investors.