What are periodic inventory systems and when are they right for your business?

Inventory management systems affect every aspect of operations, from warehouse and overhead costs to order fulfillment and generating revenue.

Two methods used to manage inventory are periodic and perpetual inventory systems. Periodic inventory systems account for inventory at regular time-based intervals, while perpetual systems continuously update inventory after every transaction.

Out of the two methods, a periodic inventory system is the simpler option, requiring less time, costs, and resources to implement.

What is a periodic inventory system?

A periodic inventory system is a method of inventory valuation where a physical count of items is conducted at specific intervals, such as the end of the year or accounting period.

Instead of adjusting inventory levels as they’re sold, a business leaves the beginning inventory in its ledger for the entire period. Any inventory purchases made during this time are instead recorded as a journal entry in a separate purchases account.

What sets the periodic inventory system apart is it only updates inventory ledgers at the end of a period by taking a physical count. Manufacturers, distributors, and retailers can benefit from periodic inventory systems, primarily if they sell in lower volumes and are looking for a simple inventory tracking method.

What is the difference between periodic and perpetual inventory systems?

Periodic and perpetual inventory systems differ in two main ways: the method and frequency of tracking.

Periodic inventory systems involve taking a manual count of all goods in stock. Because of its labor-intensive process, inventory records are updated at scheduled intervals, typically at the end of every quarter or year.

At any time between these intervals, all inventory levels are based on estimations and historical data.

On the other hand, perpetual inventory systems utilize accounting software to keep track of inventory in real-time. A barcode scanner or point-of-sale system records whenever an item is purchased, sold, or returned. These tools then automatically update a central inventory ledger, giving businesses access to accurate data at any time.

How periodic inventory systems work

Periodic inventory systems start by taking a physical inventory count at the beginning of a specific period. Aside from this initial record, no other updates are made to the inventory ledger until the next period.

If a business acquires any additional inventory, it is listed under the purchases account in a general ledger.

At the end of every period, the purchases account total is added to the beginning inventory. This amount equals the cost of inventory or cost of goods available for sale.

Beginning inventory + Purchases = Cost of goods available for sale

Take, for example, a business with a beginning inventory of $150,000. If its purchases account total is $100,000, the cost of goods available for sale is $250,000 for the given period.

A physical inventory count is also done to determine the period’s ending inventory balance during this time. The amount of ending inventory is then carried over as the next period’s beginning inventory.

The exact ending or closing inventory depends on the valuation method used by the business. For example, first-in, first-out (FIFO) will assume the first items bought were the first items sold, and the ending inventory includes the most recently purchased items. Its counterpart, last-in, first-out (LIFO), assumes the opposite and calculates ending inventory using the first items purchased.

Whichever method a business applies, the ending inventory is then subtracted from the cost of goods available for sale to arrive at the total cost of goods sold (COGS).

Cost of goods available for sale – Ending inventory = Cost of goods sold (COGS)

Continuing from the above example, if the business has an ending inventory of $50,000, its COGS is $200,000 for the period.

Benefits of periodic inventory

Using a periodic inventory system, a business only needs to update its inventory account at the beginning and end of the accounting period. This offers several benefits:

1. Easy implementation 

Periodic inventory systems are valued for their simplicity, and all it takes is some time to physically count your starting inventory at scheduled intervals throughout the year. Without complicated calculations or multiple accounting records, a periodic inventory method can be implemented without major planning or preparation.

1. Minimal cost and resources

Whereas most operations run on some type of inventory management software, periodic inventory can be done with spreadsheets—which means there are no added costs for software or training. And since inventory is only updated periodically, more resources are available for other areas of business.

1. Simplified inventory records 

For businesses with a single location or few product lines, a periodic inventory system can do the job. It’s relatively easy to keep tabs on sale transactions and estimate the current inventory levels. Plus, a simple inventory system will be easier to manage and maintain in the long run.

Disadvantages of periodic inventory

Periodic inventory can be too simplistic, especially for businesses experiencing growth or expanding to new locations. Here are some disadvantages of using a periodic system.

1. Less information and control 

In periodic inventory, the only time records are entirely accurate are at the beginning and end of the period. For the rest of the period, a business relies on estimations of its current inventory levels. If inventory falls too low or there is an undetected discrepancy in accounts, it could mean a loss in sales and customers. Not having access to real-time data can also hinder other business decisions.

1. Doesn’t allow for adjustments

Sometimes, a business will experience goods lost in transit, purchase returns, product recalls, and the like. With periodic inventory, however, there’s no way to account for these unexpected changes. Inventory records are fixed until the end of the next period.

1. Prone to human errors

Doing a physical count of all your on-hand inventory items increases the likelihood of human error. The total inventory count may be incorrect or there could be errors in valuation. Furthermore, any mistakes will be carried into the next period. To prevent this, check for any discrepancies or numbers that seem much higher or lower than expected after taking stock of all inventory.

1. Difficult to scale 

As a highly manual process, periodic inventory can be time-consuming and difficult to scale as a business grows. Performing an inventory count can also cause a bottleneck if it requires all products to be set aside for a significant amount of time.

As your product lines increase and more locations open, switching from periodic inventory to an automated perpetual inventory system may be worth it.

When should a periodic inventory system be used?

Periodic inventory systems revolve around a physical inventory count, making it suitable for businesses selling tangible products.

Ultimately, the decision to use periodic inventory depends on sales volume and available resources. In most cases, businesses selling fewer product lines or operating a single location will benefit from a simpler inventory accounting system.

Periodic inventory is also a good option for those who want to minimize costs, or don’t have the current resources to maintain inventory software.

Final thoughts

Periodic inventory systems are one of the simplest accounting processes that still enable a business to monitor its overall inventory.

While it may be too simple for those with large or fluctuating sales volumes, periodic inventory can be sufficient for a business managing fewer products.

In many cases, businesses combine both accounting methods to manage inventory. A perpetual inventory system is used to instantly record all daily inventory movements, while a periodic count is done at designated times to verify the accuracy of all accounts in the inventory ledger.