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Periodic vs. Perpetual Inventory: What’s the Difference?

Production Management
October 26, 2021
Barcoding in Warehouse Tracking Inventory

Get this - U.S. businesses carried $2,069.5 billion of inventory through July of 2021. That’s a 16.3% compared to 2020 when inventories were depleted during the early days of COVID. Further, business-to-sales ratio for inventory is 1.25, the lowest point since 2012 and reflective of the boom caused by pent-up demand.

It’s no doubt that raw materials and components account for a large portion of manufacturing costs, but not all inventory is treated equally. Manufacturers must strategically choose periodic or perpetual inventory accounting to manage this material efficiently and keep from adding unnecessary internal costs.

But which accounting system makes sense for a manufacturer? And what’s the difference between a periodic inventory system vs. a perpetual inventory system? The answer lies in the methodology, and today, the distinction is closely tied to software capability.

What Is Periodic Inventory?

Periodic inventory uses occasional inventory counts to determine the level of inventory on hand. The measurement period can be any number of set timeframes such as monthly, quarterly, or even yearly. Many companies use quarterly internal inventories throughout the year with an audited inventory at the end of the year to validate their numbers. The final measurements against the cost of goods sold (COGS) can impact financial statements, taxes, stock reporting to investors, and more.

COGS is a crucial component in the periodic inventory equation. Once COGS is completed, subtraction of COGS from sales for the measured period equals gross margins. This formula means that inventory is a direct component of margins. The formula for this is:

Inventory Beginning Balance + Purchases – Ending Inventory Cost = Cost of Goods Sold

What Is Perpetual Inventory?

Perpetual inventory systems came about in the technological age as computers allowed for tighter tracking of inventory levels. In a perpetual system, digital technology is used to update the inventory as each sale occurs. These adjustments are made automatically, so decision-makers and managers always know the level of inventory on hand.

COGS is also adjusted for each sale. This means that perpetual inventory and periodic inventory are counting the same way to arrive at gross margin. Still, the perpetual inventory method is more accurate and more reflective of day-to-day reality.

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What Are the Key Differences in Periodic vs Perpetual Inventory Systems?

Traditionally, small businesses or those with steady, predictable demand and volume have used periodic inventory. In contrast, operations with higher demand volatility, seasonality, and other unpredictable variables have relied upon perpetual inventory keeping. Yet, there are a few more critical differences in periodic vs. perpetual inventory that should be noted:

Ledger Accounts

In perpetual inventory, inventory is updated per sale, and the COGS account is too. In periodic inventory, the COGS account entry is done as a lump sum adjustment and isn’t created until inventory is counted. The distinction means that companies needing a regular or daily COGS will use perpetual accounting. Some companies may use cycle counting as a stop-gap between periods to “true-up” the counts, but it’s still less accurate than perpetual.

Labor Considerations

Periodic inventory can add labor costs to inventory keeping. A full or partial shutdown of operations is required to conduct the count as WIP inventory is part of the mix. This exercise is a significant and disruptive event for many companies. It also requires large numbers of people trained on the system and involves data entry and reconciliation after the count is conducted. Perpetual inventory is data and computer-driven and requires less labor and no shutdown to conduct.

Purchasing

Because perpetual inventory is computerized, it can be tied to the manufacturing bill of materials (BOM). Line-item inventory accounting is available for each material purchased, making purchase strategies more accurate. In periodic inventory, line-item accounting of raw materials may not be used or may be used only with additional labor and data entry. This method makes periodic inventory less accurate from a purchasing perspective.

Tracking

If an inventory error is made in periodic systems, it may take weeks or months to find the error, and the cause may never be determined. This makes inventory process improvement difficult. Because transactions are automated and detailed to the unit level in perpetual systems, errors can quickly be uncovered and improvement methods swiftly implemented.

How Software Can Work for Your Inventory

Perpetual inventory accounting requires an investment in digital technology and software platforms that were out of reach for many companies in the past. This meant businesses that could have used perpetual inventory or sorely needed to were stuck using periodic measurements that adversely impacted long-term and medium-term business decisions over time.

But the power of smart manufacturing technology changes all that. Modern ERP, SCP, IIoT, and MES systems understand the critical importance of inventory. After all, why rely on time-lagged, legacy periodic systems when the right software lets you build real-time, automatic inventory data into your business decisions?

The solutions in the Plex Smart Manufacturing Platform were built around that very concept. If you’re ready to move to a perpetual inventory system where inventory control becomes part of the end-to-end visibility of your production environment, contact us today.

About the Author

Plex Team

Plex Systems, Inc., a Rockwell Automation company, is the leader in cloud-delivered smart manufacturing solutions, empowering the world’s manufacturers to make awesome products. Our platform gives manufacturers the ability to connect, automate, track and analyze every aspect of their business to drive transformation. The Plex Smart Manufacturing Platform includes solutions for manufacturing execution (MES), ERP, quality, supply chain planning and management, Industrial IoT and analytics to connect people, systems, machines, and supply chains, enabling them to lead with precision, efficiency and agility.

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