What is Perpetual Inventory System?

Perpetual inventory system is an inventory management technique that enables continuous tracking and real-time updates of inventory levels following each transaction, thereby enhancing accuracy in inventory management and reporting while seamlessly integrating with sales and purchase systems.

A perpetual inventory system allows business owners to stay continually updated on inventory levels, avoid low stock situations and trigger automatic adjustments in reorder points. It significantly reduces the need for physical inventory counting, bringing inventory efficiency and greater inventory control.

What is the Working of Perpetual Inventory System?

Step 1: Inventory Update

When a lot is sold, the point of sale system (POS) integrated with inventory system instantly updates inventory records across purchase, production, warehouse and sales departments. Barcodes or RFID scanners make this process quick and efficient.

Step 2: Automated COGS Update

COGS is automatically recalculated and updated as soon as sales occur, ensuring accurate financial reporting by adjusting the overall COGS accordingly.

Step 3: Reorder Points Adjustment

The perpetual inventory system uses historical data to auto-update reorder points, thus maintaining optimal inventory levels by anticipating sales demand.

Step 4: Auto Purchase Orders

When inventory hits reorder point , new purchase orders are automatically sent to vendors, eliminating the need for manual intervention.

Step 5: Scanning Received Products

When items are delivered to the warehouse, the staff scans them into the system, thereby updating the inventory count and making the products available for sale.

And so, the perpetual inventory cycle goes on without needing any manual intervention.

Perpetual Inventory System Method

1. FIFO Perpetual Inventory System

FIFO ( First-In, First-Out) perpetual inventory system allows you to track and record inventory levels continuously. The cost flow assumes that the oldest stock items are sold first, and the cost of goods sold is aligned with the earliest purchase prices. It grants accuracy in financial records by showing the cost of the oldest inventory sold and also providing up-to-date inventory levels. FIFO inventory system is quite useful for businesses with perishable products with an expiry date to ensure that the older inventory is consumed before it becomes obsolete.

2. LIFO Perpetual Inventory System

LIFO ( Last In, First Out) perpetual inventory system is an inventory valuation method where the last purchased items are sold first. The cost of goods sold in this case is based on the most recent purchases. Although the inventory is continuously tracked and updated with each purchase and sale, it tends to have higher COGS, thus impacting the cash flow statement . This system is often suitable during high inflation when a business wants to reduce taxable income by increasing the cost of goods sold. Also, this inventory strategy is used to match recent inventory costs with current sales revenue.

3. Weighted Average Cost

The weighted average cost is an inventory valuation method that calculates the average cost of inventory by distributing costs evenly across all units, depicting the average investment in inventory over a specific accounting period. Weighted average cost is then used to allocate a value to cost of goods sold and ending inventory.

This method ensures consistent valuation throughout the accounting period, as it adjusts price fluctuations by averaging the cost of inventory over time.

Businesses with high inventory turnover and frequently changing purchase costs often use this approach to keep their inventory records updated, providing a consistent unit cost while promoting accuracy in financial reporting.

Weighted Average Cost Formula

Weighted Average cost = Cost of Goods Available for Sale/ Units Available for Sale

What is a Periodic Inventory System?

In contrast to a perpetual inventory system, a periodic inventory system is an inventory management technique where inventory counts are performed periodically with updates performed at specific intervals. It mandates physical counting of inventory which is conducted monthly, quarterly or at the end of a financial year to tally stocks. As periodic inventory systems offer lesser immediate visibility into the inventory levels, tracking inventory can be delayed and become challenging.

When to Implement a Perpetual Inventory System?

Using a perpetual inventory system can deliver substantial returns for your business, offering real-time margin and profitability information. A perpetual inventory system maintains correct accounting by automatically documenting sales and purchase prices. Knowing when to implement this system in your organization is important to ensure that the investment you make gives maximum returns.

If your answer to the below-mentioned question is yes, then an automated inventory management ERP system is suitable for your organization.

• Does your business have high sales volume?
• Do you feel the need for real-time inventory updates?
• Do you want to plug the gap between sales and purchase systems?
• Do you require accurate and timely financial reporting?
• Do you want to minimize stock and overstock situations?

It is interesting to note that no matter which inventory management technique you use such as ABC analysis or FSN analysis , a perpetual inventory system can effectively be applied in any situation and steadily improve ROI in managing inventory.

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