What Is a Perpetual Inventory System?

What Is a Perpetual Inventory System?

Let me explain what a perpetual inventory system is. It's a computerized method that tracks inventory levels continuously in real-time, so you can maintain accurate records without always needing physical checks. This system relies on data from electronic point-of-sale technology to give you a detailed view of inventory changes and immediate reports on stock amounts. Unlike periodic inventory systems, where you depend on scheduled physical counts, this one keeps everything updated as transactions happen.

Understanding Perpetual Inventory Systems

You might prefer a perpetual inventory system over older periodic ones because it allows immediate tracking of sales and inventory levels for individual items, helping you avoid stockouts. I find that these systems don't require manual adjustments by accountants, except when they differ from physical counts due to loss, breakage, or theft. The software uses barcode scanners or other computerized records to update inventory in real-time for acquisitions, sales, and returns, feeding into a constantly adjusted database. This setup integrates with finance and accounting teams, ensuring compliance with regulations, and lets employees provide better customer service on product availability.

Perpetual vs. Periodic Inventory Systems

The key difference between perpetual and periodic systems is how they function, but it extends beyond that. Perpetual systems track sales constantly and immediately via point-of-sale tech, while periodic ones only update when you order a physical count at a specific time. If you're running a large company or dealing with complex inventories, a perpetual system suits you better; smaller companies with simple stock can manage with periodic. The margin for error is smaller in perpetual systems, and COGS gets updated constantly rather than periodically. Overall, once set up, perpetual systems require less effort than physical ones, though startup costs are higher.

Advantages and Disadvantages of Perpetual Inventory Systems

When considering perpetual inventory systems, you should weigh both sides. On the advantages, they provide real-time updates on purchases and sales, so you and your team can monitor and use this data as needed. They help with informed forecasting by tracking customer patterns and seasonal changes, allowing you to stock efficiently and avoid losses from excess or shortages. Managing inventory across multiple locations becomes easier with a connected system, creating fulfillment opportunities like shifting stock. Preparing financial statements is simpler since inventory value is readily available, speeding up reports and reducing manual errors. Plus, you avoid downtime or store closures that come with frequent physical counts in periodic systems.

Now, for the disadvantages, these systems don't account for stock loss from damage, spoilage, or theft, so discrepancies show up only in physical checks. Improper tracking can occur from scanning errors, misplacements, software issues, or employee mistakes, which hampers operations. Hacking is a risk, threatening data security and requiring expensive cybersecurity. The costs are high upfront for equipment, software, and training, with ongoing updates adding to expenses—small companies might find it unaffordable. And despite everything, you'll still need periodic physical inventories, though less frequently.

When to Use a Perpetual Inventory System

You should consider a perpetual inventory system if you're a large company with high-volume, rotating inventory or multiple locations. If your business is growing and anticipates these needs, it might be worth planning for one now. Factors like your margins and ability to afford setup and ongoing costs, the size of your inventory, and how vendors handle different management methods also play a role.

How to Use a Perpetual Inventory System

To calculate inventory in this system, set up where every item is entered and deducted as sold, using point-of-sale terminals, barcode scanners, and software for real-time updates with each purchase and sale. Remember, it estimates stock but doesn't replace physical inventories— you'll need those occasionally. Many businesses use cycle counting, physically counting portions over time to baseline and verify the system's accuracy.

Inventory Management

Inventory management involves ordering raw materials, storing and using them to create products, and selling to end users. Common methods include just-in-time (JIT), material requirements planning (MRP), economic order quantity (EOQ), and days sales of inventory (DSI), each with pros and cons in a perpetual system. Perpetual systems make EOQ easy, as it's a formula for deciding when to buy based on holding and ordering costs.

Cost of Goods Sold (COGS)

In a perpetual system, selling products increases the expense account and COGS, which covers production costs like materials and labor during a period, excluding distribution or sales. The formula is COGS = Beginning Inventory + Purchases - Ending Inventory. This system gives a continuous tally, so COGS is always available, unlike periodic systems that calculate it only after a count. You get rolling estimates to respond quickly to cost changes.

Calculating Gross Profit

Gross profit is revenue minus COGS, where COGS excludes sales or distribution costs. The formula is Gross Profit = Revenue - COGS. With perpetual systems recording transactions in real-time, you can estimate gross profit continuously.

Examples of Inventory Costing Systems

Companies choose methods like FIFO (assuming oldest units sold first), LIFO (newest first), or weighted average (total cost divided by units) for inventory costing. The total expensed cost is the same, but timing differs for when costs are recognized.

The Bottom Line

More businesses are shifting to perpetual inventory systems over physical-count periodic ones, as they're costly to implement but save time and money long-term. They provide updated stock estimates and accounting integration but can't track losses without partial physical counts. Small companies often stick with periodic, while large or multi-location ones adopt perpetual for labor savings despite high startup costs.