Perpetual Inventory System

What is a perpetual inventory system?

The perpetual inventory system is a method in which inventory is tracked, and the inventory records are updated automatically as soon as a transaction occurs, such as a purchase or sale.

When this system is being used by a warehouse, a purchase of inventory would automatically increase the purchases in the accounting records to ensure the inventory is reflected accurately in the inventory account.

When using this method, a company does not need to make any kind of effort to keep detailed records on paper because the sale of goods is reflected in the database through credit.

Perpetual inventory systems and periodic inventory systems differ in that a company maintains inventory records by physically checking them when using a periodic inventory system.

Perpetual vs. Periodic Inventory Systems

Whenever a sale is completed, the point-of-sale system enables a change in inventory levels; consequently, there is an increase in the cost of goods sold (COGS) account.

Operating with a periodic system would require the management to physically count the inventory before making any accounting entries, whereas inventory reports are easily available online while using a perpetual inventory system.

High-value product-selling firms such as vehicle dealers and jewelry stores should focus more on inventory management, considering their high working capital requirements. However, they also maintain a point-of-sale system. 

Inventory counting or checking of inventory happens quite frequently in both methods. However, the purpose of doing so in the case of a periodic system is to prevent theft of assets, whereas, on the other hand, it is done to utilize record keeping.

When to use a perpetual inventory system

A company that wants to accurately understand its inventory levels in real time should employ this method of inventory calculation. 

The system's importance increases even more when the company needs to make huge investments and offers a wide variety of products, such as a shopping complex.

If a perpetual inventory system is not in place, a business won’t be able to forecast the demand accurately. Businesses growing rapidly also use this system to check their working capital investments.

Moreover, businesses that have booked customer orders will have to manage their inventory with this system to understand the inventory balances precisely. However, there are situations in which this system is not required.

When the cost per unit of inventory is low, management can maintain a large inventory with a small investment. 

Moreover, industries in which products are manufactured on customer’s demand only purchase the raw materials, so real-time monitoring is not required.

An e-commerce business can get a precise measure of inventory in hand in real time without the tedious process of counting inventory manually. A perpetual inventory system would reduce the time and capital required to manage inventory.

Advantages of Perpetual Inventory Systems

Some of the advantages are described below:

1. Real-Time Updates

Continuous inventory tracking enables management to identify which items are low in stock at the right time. This is because this system records inventory sales and purchases in real-time as soon as the transaction happens.

2. Managing Multiple Locations Easily

A perpetual inventory system is of most importance to MNCs operating in different locations worldwide. However, it will be difficult to physically count and keep a record of the same on hand for other places.

However, when a perpetual inventory system is in place, it becomes effortless for the management to forecast the demand and order the raw materials to be used in production.

3. More Informed Forecasting

A constantly updating inventory system allows management to find patterns in product demand. This data allows a company to forecast demand and develop a supply chain accordingly for future years.

For example, an ice cream chain can determine whether a specific time of the day leads to a spike in demand or a particular weather condition drives excess demand for a specific flavor if its inventory is managed and updated constantly.

Disadvantages of Perpetual Inventory Systems

Regarding the disadvantages, we can explain the following: 

1. Expensive Technique

Operating under this type of system is expensive. Updating the technology necessary for the system, such as scanners and barcodes, can be a considerable expense.

Training and development costs of new employees are another expense the company has to bear. Hence, this system is unsuitable for firms operating in a low-margin industry.

2. Breakages and Spoilage Not Accounted For

Purchase and sale data is used in order to update inventory levels while using a perpetual inventory system. 

Products that become spoiled or damaged after being stored in the warehouse don’t become the management's concern until and unless the administration carries out a physical count. 

However, a physical count is not associated with a perpetual inventory system. Therefore, the management counts damaged products as inventory unless the physical count occurs. 

Hence, there are chances that the management might be making mistakes while using this system.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Accounting Ratios
• Cost Allocation
• Deferred Revenue
• Normal Profit
• Revenue vs Income