Imagine the ability to conjure up your stock levels with a click, having real-time insights into your inventory any hour of the day, and never being blindsided by a surprise “out of stock” notification.
This is all possible thanks to perpetual inventory systems. This revolutionary approach to stock management has redefined efficiency and accuracy in businesses worldwide.
Let’s unravel its benefits and how it can transform your business.
What is Perpetual Inventory?
The perpetual inventory method is an innovative system of inventory accounting that meticulously records alterations in inventory records the instant they occur.
Whether it’s a product sold, processed, or newly received, every activity is immediately updated in the inventory data. The perpetual system essentially keeps a constant, up-to-date account of your inventory.
In essence, a perpetual inventory system is an approach to inventory management that reconciles inventory in real-time.
This method eliminates the lag between the physical inventory and the accounting records.
Every adjustment is instantly reflected in the system, offering a comprehensive view of your inventory status at any moment.
On the other hand, the traditional periodic inventory system requires manual physical inventory counts.
This means that inventory updates are not immediate, and the records might not always reflect the actual state of your inventory.
Manual counts can introduce the risk of errors, delays, and inefficiencies.
Here’s where the role of perpetual inventory software comes into play.
As soon as a transaction occurs – be it a sale, a return, or the addition of new stock – the software automatically updates the inventory records, eliminating the need for manual intervention.
Whether you are a small business owner looking to streamline your inventory processes or a large enterprise aiming for optimal efficiency, the perpetual system (supported by perpetual inventory software) could be your key to:
- Enhanced inventory accuracy
- Reduced stockouts and overstock situations
- Improved business performance
What is a Perpetual Inventory System and How Does it Work?
One of the main differences between the perpetual and periodic inventory systems is how inventory is tracked.
Let’s take a closer look.
What Is a Perpetual Inventory System?
In simple terms, a perpetual inventory system is a technology-based method of inventory management used to track stock as it is sold or received in real time.
The technology supporting perpetual inventory methods is typically an eCommerce platform (like Shopify), a computerized point-of-sale system or dedicated inventory management software.
Regardless of which technology is used, it collects data automatically and displays detailed changes to your stock levels as they occur.
What is a Periodic Inventory System?
A periodic system, on the other hand, is the total opposite. It is done physically, which means that stock has to be counted physically by a staff member before it can be compared to sales data.
An easy way to remember this is that periodic systems “periodically” record data, while perpetual systems are “perpetually” running in the background, recording all relevant inventory information.
Periodic inventory methods leave much room for error and are not the most inefficient inventory management systems.
A real-world example of perpetual and periodic inventory systems
These concepts may seem abstract or academic in theory, but let’s look at a real-world eCommerce example of these two systems in practice.
Imagine you own a hypothetical eCommerce store selling personal electronics.
In a perpetual inventory system scenario, a customer orders a pair of wireless headphones from the online store.
When the sale is processed and the order confirmed, the inventory database gets immediately updated, deducting the sold pair of headphones from the stock count.
There’s no need to wait until the end of the day or week to know exactly how many headphones are left in stock.
This real-time data keeps the company informed about when to reorder, preventing potential stockouts.
Moreover, when the business restocks the wireless headphones, the inventory software instantly updates the database to reflect the new stock levels.
(This is even easier if the inventory management system integrates with a barcode scanning system.)
This automation saves the business time and effort, ensuring the inventory record is always accurate.
This real-time data can offer valuable insights into sales trends and patterns, enabling the business to make data-driven decisions.
Now, contrast this with a periodic inventory system.
In this scenario, if a customer purchases the same pair of wireless headphones, the inventory records wouldn’t immediately be updated.
Instead, the business would wait until the end of a set period (e.g., day, week, or month) to manually count and update the inventory levels.
While this approach might work for smaller businesses with less frequent transactions, it poses several challenges for growing eCommerce businesses.
Firstly, the delay between the sale and the inventory update could lead to discrepancies between the actual and recorded inventory levels.
This could result in the business unknowingly selling more headphones than they have in stock, leading to stockouts and unhappy customers.
This is especially risky when selling on multiple marketplaces, each with its own stock levels and allocated inventory.
Secondly, periodic inventory systems can be time-consuming and prone to human error.
Manual counts might not always be accurate, potentially leading to mistakes in the inventory records.
Plus, without real-time inventory updates, the business might lack the necessary data to make informed restocking decisions or promptly identify and respond to sales trends.
So while periodic inventory systems might be simpler and less costly upfront, the potential for errors, inefficiencies, and lack of real-time data can prove costly in the long run.
On the other hand, perpetual inventory systems, with their real-time updates and automation, offer a more efficient and accurate approach to inventory management, particularly for growing eCommerce businesses.
Major Differences of Perpetual Inventory Control Systems
Here are some key features that distinguish a perpetual inventory control system from a simple perpetual inventory system:
A perpetual inventory control system typically includes analytics tools that allow users to analyze inventory data, identify trends, and make informed decisions about purchasing, pricing, and stocking levels.
A perpetual inventory control system may support decision-making by recommending reorder points, safety stock levels, and other inventory management parameters.
Some perpetual inventory control systems include forecasting capabilities that allow users to project inventory levels based on historical data and anticipated demand.
Integration with other systems
A perpetual inventory control system may be integrated with other systems, such as point-of-sale (POS) systems or supply chain management (SCM) systems, to provide a complete view of inventory levels and trends.
A perpetual inventory control system may allow users to create custom reports that provide insight into specific aspects of inventory management, such as inventory turnover, stockouts, or slow-moving items.
Some perpetual inventory control systems support multiple locations, allowing users to track inventory levels across multiple warehouses or stores.
A perpetual inventory control system may offer mobile access, allowing users to monitor inventory levels and make informed decisions on-the-go.
When Should You Use a Perpetual Inventory System for Your eCommerce Business?
A perpetual inventory system is the best way forward if your retail business handles a high sales volume, as most eCommerce brands do.
However, even small businesses will benefit from this inventory management system to simplify and automate inventory-related tasks.
The Advantages and Disadvantages of a Perpetual Inventory System
A perpetual inventory system is far superior to a periodic inventory system for your eCommerce business for various reasons. The biggest advantage, bar none, is that it significantly reduces human error. Other advantages include:
Since everything depends on technology, stock levels are instantly updated using the perpetual inventory management system. You can say goodbye to the time-consuming task of performing a physical inventory count and the resulting business downtime and missed sales opportunities.
As a bonus, you get a warehouse organization that is more efficient and saves employees time. You also enjoy lower supply chain costs, improved cash flow, and a boost to your company’s bottom line.
It improves your forecasting
Accurate forecasting is a critical component of effective inventory management. Cisco, the networking equipment behemoth, learned the hard way about the consequences of poor stock forecasting in 2001.
It had to write off about $2.25 billion in equipment components and raw materials as a loss.
Your business may not be on that scale yet, but a loss is a loss — it still hurts. With the assistance of a perpetual inventory system, you can avoid a loss to your business.
Because you can keep track of all transactions, you can ensure full product accountability on demand.
Records in real time
A perpetual inventory system is also more accurate than a periodic inventory system.
The reason for this is simple: because key inventory management tasks are automated, sales and inventory data are recorded as soon as they occur, which has positive applications for stock forecasting and audits.
This means that your eCommerce business will have a more accurate inventory account whenever needed.
As a result, you can take steps to avoid stockouts, as well as product and production shortages.
Reduce inventory management costs
A perpetual inventory system provides a comprehensive data set of all metrics related to your inventory.
The best part is that once the costing system formula is correctly set up, analyzing this data is relatively simple (more on this later).
This has a positive knock-on effect in reducing the money you spend on inventory management. With the data, you can more accurately forecast demand and avoid excess raw materials and stock.
You can also scale up or down the cost of holding stock based on demand, ensuring that you are not paying for storage you do not require and vice versa.
Disadvantages of Perpetual Inventory Systems
Before we get into the cons of the perpetual inventory system, it is important to note that while some of the following points are listed as cons, they’re more like minor inconveniences when compared to the alternative (periodic inventory system).
Annual physical stock audit
Even if you have a perpetual inventory management system, you must count your inventory to synchronize your data physically.
This count is required because recorded inventory may not accurately reflect what is physically in stock over time, let alone accounting for drop shipments or inventory on order, including accounting for breakage, stolen goods, and loss from shrinkage (which are risks associated with stock in your business).
If you’re looking for the most efficient ways to audit your inventory, look at our post on cycle counting.
Shrinkage occurs for various reasons, including supplier error, employee theft, and paperwork errors.
It’s a costly problem for your business that can result in a loss of profit: you cannot recoup your inventory costs, and you cannot sell the inventory to generate revenue.
The good news is that shrinkage can be deducted from your personal or business tax returns when discovered. The meticulous records provided by a perpetual inventory system can assist with this.
Constant record keeping and monitoring
More data means more responsibility. Because perpetual inventory systems are designed to track and record every inventory transaction, you must establish an equally robust record-keeping and monitoring system for all data collected.
Errors and incorrectly scanned items can have an impact on your inventory records.
Fortunately, you can deal with this mathematically by using formulas (corrections) that account for most of these factors. We’ll get to that in a minute.
Higher setup costs
Perpetual inventory systems may be more expensive to implement the periodic inventory management method due to the software, equipment, and training needs.
However, the initial setup costs more than pays for itself in real-time inventory updates and accurate stock on-hand accounting.
These features help your eCommerce business avoid stockouts and encourage minimal employee contact with the inventory.
How Is Inventory Tracked Under a Perpetual Inventory System?
We’ve already established that a perpetual inventory system works by instantly updating stock counts as purchased or sold. But how does a perpetual inventory system work in practice?
This guide focuses on five critical functions of a perpetual inventory system — inventory level, COGS (cost of goods sold), reorder points, purchase orders, and received stock.
Note: the process may differ slightly when integrated into your business and depends on how your supply chain is structured. We recommend scheduling a demo so we can customize SkuVault to suit your specific needs.
1. Inventory Level
When a product is sold, an RFID (radio-frequency identification) or barcode scanner is used to notify the inventory management system linked to your point-of-sale system of a debit update.
This change is then recorded by the system and distributed to all sales channels.
2. COGS (Cost of Goods Sold)
The Cost of Goods Sold, commonly known as COGS, is a critical financial metric that indicates the direct costs of producing the goods a business sells.
This includes the cost of materials and labor directly used to create the product.
In the context of a perpetual inventory system, COGS doesn’t remain a static figure but is continuously updated and recalculated in real-time, just like your inventory levels.
Let’s delve deeper into how this works.
Every time an item is sold, the cost associated with that particular product is added to the COGS for the period.
This is done automatically in a perpetual inventory system. Similarly, when an item is added to your inventory, the cost of acquiring or manufacturing that item is also considered.
Therefore, any fluctuation in your inventory—be it addition or subtraction—immediately impacts the calculated COGS.
The real-time update of COGS in a perpetual inventory system offers a significant advantage. It provides businesses with immediate visibility into the direct costs of sold goods. This data can help businesses make informed pricing, marketing, and purchasing strategy decisions.
For instance, if the COGS escalates, a business might need to consider increasing its selling prices or seeking cost-effective production methods.
Or, if the COGS is relatively low, it could signal an opportunity to offer promotional discounts to boost sales without compromising profit margins.
Moreover, real-time COGS data enhances financial reporting accuracy. Since COGS is a key determinant in calculating gross profit (Revenue – COGS = Gross Profit), updating COGS data contributes to accurate profit calculation and effective business analysis.
3. Reorder Points
Reorder points are critical to effective inventory management, signaling when to reorder products to maintain optimal inventory levels.
These reorder points aren’t just fixed numbers within the perpetual inventory management system. Instead, they can be dynamically updated based on historical inventory and sales data.
In essence, a perpetual inventory system records all transactions related to each SKU, providing valuable insights into patterns such as sales velocity, seasonal demand fluctuations, and lead time from suppliers.
As a result of this accumulated historical data, the system can intelligently adjust reorder points in real-time to match the flow of your business’s sales volume.
For example, if a particular product’s sales rate suddenly increases due to seasonal demand, the system will detect this change and automatically reduce the reorder point, ensuring timely restocking.
Conversely, if a product’s sales slow down, the system can raise the reorder point to prevent overstocking.
This dynamic adjustment of reorder points contributes to maintaining optimal inventory levels, reducing the risk of stockouts and overstock situations.
It ensures you have the right stock at the right time, ultimately improving customer satisfaction and business efficiency.
4. Purchase Orders
Creating and sending purchase orders in a perpetual inventory system becomes automated, further streamlining your inventory management.
When an SKU reaches its specified reorder point, some systems can automatically trigger a purchase order, negating the need for manual monitoring and intervention.
This means the moment your inventory for a particular item drops to its reorder point, a new transaction order detailing the required quantity of the item is generated.
This order is then automatically sent to your supplier.
This process ensures timely restocking and prevents potential stockouts that could interrupt your business operations and negatively impact customer satisfaction.
Furthermore, this automation minimizes human errors often associated with manual purchase order creation, such as incorrect quantities or wrong supplier details.
It also saves time and resources, allowing your team to focus on more strategic tasks rather than routine inventory monitoring.
5. Received Products
The reception of products is an essential step in the inventory management process. Perpetual inventory systems like SkuVault are intricately designed to integrate with warehouse management software seamlessly.
This results in a streamlined, efficient process for managing incoming stock.
Here’s how it works: As soon as your stock arrives at your warehouse, it is scanned using barcodes, QR codes, or RFID tags.
The data is directly communicated to your inventory management system during this scanning. This automation ensures that your inventory records are immediately and accurately updated to reflect the new stock.
This real-time update offers several advantages:
- It ensures the accuracy of your inventory records, reducing the possibility of discrepancies between the physical stock and the recorded data.
- It provides immediate visibility into the current inventory levels, enabling you to make informed decisions about restocking, sales, and marketing strategies.
- It helps streamline warehouse operations.
By immediately registering incoming stock, the warehouse management software can efficiently guide the placement of products, optimize space usage, and facilitate quicker, more organized order fulfillment.
A perpetual inventory system is fundamentally built on continuous data collection and utilization at every stage of the inventory management process.
From initial sales and product processing to reorder points and receiving new stock, each step is meticulously tracked and looped indefinitely as long as the system is operational.
This continuous data flow cycle ensures a smooth, uninterrupted supply chain, contributing to efficient operations, reduced errors, and improved customer satisfaction.
It takes the guesswork out of inventory management, replacing it with accurate, real-time data that empowers businesses to make strategic, informed decisions.
Formulas in Perpetual Inventory
Businesses use various methods to account for the cost of available inventory. Regardless, the total inventory cost invoiced remains constant.
When using a perpetual inventory system, these inventory costing systems or formulas provide a more efficient way to keep track of inventory counts.
Below, we’ve compiled a list of the most popular methods and how you can apply them to your business.
The First In, First Out (FIFO) Approach
The principle underlying this approach is simple: ensure that stock is purchased in the same order in which it was created or purchased.
This method is useful if you keep perishable goods on hand.
It is also advantageous to stock non-perishable goods because items stored for an extended period may need to be updated, damaged, or otherwise unsellable.
One of the most effective ways to incorporate FIFO into your perpetual inventory process is to add new products from the back of your stockroom, ensuring older stock is the first off the shelf when an order arrives.
The Last In, First Out (LIFO) Approach
Unlike the FIFO method, which calculates the cost of goods sold in the order they were received, the LIFO method calculates the COGS (cost of goods sold) using the cost of the most recent stock purchase order.
In simpler terms, inventory is calculated and adjusted based on the total cost of a purchase order and then compared to sales data, in contrast to inventory levels being changed with each sale.
Weighted Average Cost Approach
The weighted average cost approach determines how much stock has sold and the current inventory levels at any given time.
It is calculated as COGS/total number of stock in inventory.
Finished Goods Approach
Businesses use finished goods inventory counting to determine how much stock is available to ship out as soon as an order is placed.
It is commonly used by businesses that stock raw materials and finished goods.
It is also used to forecast inventory costs by calculating the total cost of inventory(raw materials and finished goods).
Formula: Previous Year’s Finished Goods Value + (COGM – COGS)
Economic Order Quantity
Economic order quantity (EOQ) is your business’s optimal purchase order for its inventory to maximize warehousing space and minimize stockouts.
It is calculated by taking the square root of [2SD] / H = EOQ.
Where H stands for Holding Cost (per unit, per year),
S is Setup fees (per order including handling and shipping),
D is the demand rate (average quantity of stock sold annually).
Giving your company better inventory management tools ensures its overall success.
Combined with a perpetual inventory system, these tools are an excellent way to manage your inventory effectively.
However, selecting a perpetual inventory system is only one part of the equation; you will also need the right software, integrations, and partners to optimize your logistics efforts.
SkuVault can be your one-stop shop for everything inventory.
SkuVault empowers you to spend less time on inventory management tasks while maintaining complete insight into your supply chain.
Schedule a demo today, and we’ll show you how we can help you work on your business rather than in it.