The two main types of inventory systems give a small business flexibility about how to track its inventory. A perpetual system keeps an ongoing record of the inventory balance, and a periodic system records the amount every once in a while. Although both systems work, their differences should be kept in mind when choosing which one is best for your company.
Perpetual Inventory System
A perpetual inventory system constantly maintains the amount of inventory owned and sold. The greatest benefit of this system is always having an accurate idea of how much inventory your company is carrying. At any time, you are able to check your balance sheet and see the total dollar amount of inventory. Another advantage of a perpetual inventory system is its automation. Because the inventory balance is always maintained, your accounting system automatically counts and reconciles inventory. The number one item to think about regarding a perpetual inventory system is the cost. Because you need software that communicates with every purchase and sale made, a perpetual inventory system is more expensive than other systems. Plus, there are ongoing maintenance costs to consider to ensure the inventory system is running correctly.
Periodic Inventory System
A periodic inventory system is a method of occasionally counting inventory. The financial statements still track and report inventory; however, knowing the exact amount of inventory at all moments is not a priority. Instead, inventory is reconciled on a monthly basis to get a sense of obsolescence, theft, and business activity. The main benefit of a periodic inventory system is its simplicity. It requires less maintenance and is more affordable. However, a periodic system is most likely going to be manual. This means you have to count the amount in inventory at the end of each month. In addition, the amount reported as your cost of goods sold is estimated. Therefore, a periodic inventory system sacrifices a bit of quality.
Choosing Between the Two Systems
Picking between these two general inventory methods typically comes down to two questions. First, a business should address whether it needs to know its inventory balance at all times. This may be very important in some industries. Plus, when trying to secure loans, you want the most accurate information. Second, a business should decide how much money it is willing to spend on an inventory system. A perpetual system costs more than a periodic system. Another factor to consider is your security over inventory. If your goods are susceptible to theft, it may be wise to have stronger internal controls. In cases where you want more security over your items, a perpetual inventory system immediately lets you know if something is unaccounted for; because a periodic count may not happen for an entire month, your response time is usually slower. Consider what the task of counting your inventory will look like. Do you have many unique items, or do you have thousands of small items? Are your inventory items valuable, or would miscounting one inventory item not make as much of a difference? In some cases, one system triumphs over the other; it’s just a matter of deciding which of the two methods works best for you.