Perpetual Inventory System
If your business uses a periodic inventory system where you frequently update your stock levels and conduct physical stock takes, the idea of an inventory system that updates automatically in real time sounds pretty enticing. Indeed, transitioning to a perpetual inventory system has many advantages, including saving you time and providing you with more accurate inventory records. Learn more about perpetual inventory and how you can implement it in your own business.
What Is a Perpetual Inventory System?
A perpetual inventory system is a method for tracking stock quantities using sales and purchasing records. It’s in opposition to a periodic inventory system, which requires manually counting inventory on a regular schedule. A perpetual inventory system requires specialized stock tracking software, which automatically deducts and adds items to your stock quantities based on your sales and purchases. Businesses that sell goods in physical retail stores also require a point of sale (POS) system, integrated with the inventory software, to decrement sales in real time.
For the most part, a perpetual inventory system requires no manual data entry. The stock quantities automatically rise and fall thanks to integrations with your sales channels and a purchasing and order management system included with the inventory software. The only manual adjustments required occur when the automated count falls out of line with physical counts, which occurs when an item breaks or gets lost or stolen. A physical count once a year is usually sufficient to correct these records.
A perpetual inventory system also has some unique accounting applications. Under the perpetual inventory tracking system, businesses can keep a running total of the cost of goods sold and the cost of goods available for sale. Therefore, the accounting team doesn’t have to maintain a separate purchases account because purchases are directly attributed through the inventory account.
How to Use a Perpetual Inventory System
A perpetual inventory system starts with a system for automatically logging sales and purchases. For many businesses, that means using barcode scanners to track inventory and the point of sale. In Finale Inventory, you can log purchases automatically by creating your purchase orders directly in the software. If you use reorder point settings, purchase orders will automatically generate the quantities you need, using costs from your supplier catalogs. All you have to do is hit send.
Once you have a system that tracks your inventory in real time, you can apply a perpetual inventory accounting system. To do so, you must understand the accounting concept of “cost of goods sold,” or COGS. Essentially, COGS is all the direct costs incurred to acquire and manage merchandise before it’s sold. It includes purchasing costs, labor and materials but not distribution or sales costs. The COGS formula is beginning inventory plus inventory purchases, minus ending inventory.
In Finale Inventory, we handle this using the average costing method. The key here is that every average COGS is calculated at the time of transaction since this system is perpetual. For example, before you make a sale, you purchase units at two different price points. When the sale occurs, the COGS recorded is an average of the purchasing prices at that time.
If you later purchase more units at a third price point, that’s not factored into the COGS for previous purchases. However, the COGS will be recalculated on your next sale to include the most recent purchasing cost. If you use Finale Inventory, your average COGS updates automatically based on your purchasing records.
Using Perpetual Inventory Accounting
Once you understand your average COGS, you can create the appropriate accounting entries for every inventory transaction. Some events that require an accounting entry include:
- Purchasing inventory: Debit your inventory account and credit your accounts payable.
- Incurring inventory-related expenses, such as shipping: Debit your inventory account and credit your cash or accounts payable.
- Returning goods to a supplier: Debit the accounts payable and credit the inventory account.
- Selling inventory: First, debit your accounts receivable and credit your sales. Then, debit your COGS and credit your inventory account.
- Accepting customer returns: First, debit your sales account and credit your accounts receivable. Then, debit your inventory and credit your COGS.
- Adjusting inventory after a physical count: Mark your inventory over and short account with a debit and credit your inventory account.
How a Perpetual Inventory System Works
The perpetual inventory system follows four steps. With powerful real-time stock management software leading the process, very little has to be performed manually. The steps in a perpetual inventory management system include:
- Point of sale: If you have a brick-and-mortar store, you’ll log sales using a POS system compatible with your inventory management software, such as Lightspeed or Square POS. If you sell online, you’ll integrate your inventory software with your e-commerce channels, such as Amazon or your online shopping cart platform. When a sale happens on any platform, the inventory records the selling price update in your central database.
- COGS recalculations: When a sale is recorded, the COGS updates according to the costing averages of recent stock purchases listed in the inventory software.
- Automated reorder point calculations: Another benefit of perpetual inventory tracking is keeping items stocked at optimal levels. Your inventory software uses a dynamic reorder point formula that accounts for your current sales trends, current inventory levels, desired buffer stock and supplier lead times. It’ll calculate precisely when and how much to reorder and generate a purchase order for you to sign and send. Confirmed purchase orders provide the latest pricing information to update the average COGS on future sales.
- Replenished inventory: When new stock arrives in your warehouse, your employees use a barcode scanner to add the new inventory to your system. This step updates your inventory levels in your central database alongside your POS and online sales channels.
What Are the Advantages?
The beauty of a perpetual inventory system is more accurate inventory records with less manual work, so your inventory managers can enjoy more infrequent stock counts. If you use inventory management software that integrates with your accounting software, your accounting team can watch your COGS and inventory transactions update in real time.
Some of the benefits of this system include:
- Real-time data: Real-time data helps your team make better decisions and prevents many inventory issues, such as overselling. With real-time inventory records, your available quantities push to your online marketplaces every five minutes. It prevents you from selling stock you don’t have and ensures the stock you have available is listed online.
- Decreased costs and increased sales opportunities: Tracking inventory perpetually means you’re less likely to overstock or understock. You can also safely keep less buffer stock, knowing that a reorder point calculation will help you reorder before your current inventory depletes. This capability saves on holding costs and prevents you from losing sales opportunities.
- Accurate accounting records: Using information from your sales and purchasing records, your inventory management software can perform many inventory-based accounting procedures and push the data automatically to QuickBooks Desktop or QuickBooks Online. It saves your accounting team considerable time and provides you with many valuable financial reports and documents.
- Demand forecasting: Using inventory software that can automatically forecast your inventory needs based on your sales velocity is crucial for helping your business grow. You’re less likely to hold excess inventory or run out of stock as your demand increases.
Perpetual Inventory vs. Periodic Inventory
You may be more familiar with periodic inventory since it’s more common for small businesses and those just starting out. This system requires more frequent physical stock counts to measure inventory and the COGS. Usually, companies handle periodic inventory using spreadsheets and perform manual calculations.
Some key differences between periodic inventory and perpetual inventory include:
- Business stage of development: While a business at any stage can benefit from perpetual inventory management, only new and very small businesses can work effectively with a periodic inventory system. Once a business starts growing and working with higher sales volumes, perpetual inventory is necessary to track merchandise effectively. In fact, it’s a critical investment that can stimulate business growth by cutting inventory holding costs, improving stock availability and reducing shipping times.
- Software and hardware usage: Perpetual inventory management requires several types of software, including POS software with the related hardware and the inventory management solution — possibly with integrated barcode scanner hardware. While a periodic inventory system requires no special software, it still benefits from accounting software and digital spreadsheets.
- Frequency of physical counts: Periodic inventory management relies on physical stock counts. Depending on the industry and the way merchandise moves, physical counts could happen each year, quarter or week. Physical counts are much less frequent in a perpetual inventory system and may be performed as infrequently as once a year.
Schedule a Finale Inventory Demo
Finale Inventory is a flexible, scalable inventory management solution that makes a perpetual inventory system possible. We help businesses scale by cutting out manual processes and giving business owners access to real-time data, in-depth insights and easily accessible financial reporting. Schedule a Finale Inventory demo to discover how our inventory management system can change the way you do business.