As a small business owner, keeping track of inventory is an essential part of running your business. Perpetual inventory is one solution for inventory accounting. Read on to learn more about what is perpetual inventory, how perpetual inventory systems work, and the pros and cons of perpetual inventory.
What is perpetual inventory?
Businesses have a variety of options for tracking inventory, including the periodic inventory method, perpetual inventory method, or a mixture of both methods.
Perpetual inventory is an accounting method that records the sale or purchase of inventory through a computerized point-of-sale (POS) system. The perpetual method allows you to regularly update your inventory records to help prevent situations like running out of stock.
You can easily record, view, and access changes in your inventory. You will have ongoing, accurate results if you properly manage your perpetual inventory by updating it on a regular basis.
Perpetual vs. periodic inventory
The periodic inventory system relies on physical inventory count to determine your ending inventory and cost of goods sold. You update your accounts at the end of your accounting period. Your accounting period might be once a month, quarter, or year.
A perpetual inventory system keeps continual track of your inventory balances. Updates are automatically made when you receive or sell inventory. Purchases and returns are immediately recorded in your inventory accounts.
For example, a grocery store may use a perpetual inventory system. Each time a product is scanned and purchased, the system updates the inventory levels in a database.
How perpetual inventory works
When you use perpetual inventory, the POS system automatically makes changes to your inventory levels. You can access your inventory reports online anytime, making it easier to manage or purchase inventory.
However, perpetual inventory systems are not entirely correct all of the time. There are many factors that can affect the accuracy of your business’s inventory levels. You may forget to record a transaction or experience employee theft at your business. Be sure to occasionally check your actual inventory quantities to compare totals.
The calculations for perpetual inventory are typically done as you go versus waiting until the end of the accounting period, like with periodic inventory. Businesses that use POS systems and sell high-value items (e.g., car dealerships) usually use perpetual inventory systems to frequently count inventory.
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Inventory costing systems
Your business can choose from several methods to account for inventory held in your perpetual system. Review the three inventory costing methods below.
FIFO
The first in, first out (FIFO) method presumes the oldest units are sold first. FIFO means that the goods you purchased or manufactured first are the ones you sell first.
LIFO
The last in, first out (LIFO) method means you sell your newest purchased or manufactured goods first.
Average cost
The average cost method is your total inventory cost divided by the number of goods in your inventory.
Perpetual inventory system pros and cons
Like many things in business, perpetual inventory has its advantages and disadvantages.
Some pros of perpetual inventory include its ability to provide up-to-date inventory information instantly, its easy access system, and how it reduces the requirement to count physical inventory.
On the other hand, some cons may include additional training for employees to use the system, setup costs, and incorrect inventory levels from mistakes such as entering the wrong quantity. If you or your employees make mistakes while entering inventory, fixing the error can be time-consuming.
Periodically compare your accounting books to on-hand inventory to ensure your inventory balances are correct. If necessary, you can always adjust the balances.
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This article has been updated from its original publication date of December 18, 2018.
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