What is a Perpetual Inventory System?

A perpetual inventory system is both a business practice of inventory management and a software solution. As a process, it is a type of accounting in which changes in stock are recorded in real-time during the sale of goods or replenishment of warehouses.

The perpetual inventory implementation tool is a software registration system that logs each transaction related to the movement of stocks on the back end. This allows company salespersons to have up-to-the-minute information about available stock. This inventory method records stock in monetary and physical terms in real-time throughout the reporting period.

Read about customer case files of real-time inventory for successful B2C/B2B ecommerce and offline sales in our blog post Challenges of Real-time Inventory Management and its Implementation in B2C and B2B eCommerce.

1. WHAT IS PERPETUAL INVENTORY?
2. WHY USE A PERPETUAL INVENTORY SYSTEM?
3. FORMULAS IN PERPETUAL INVENTORY
4. WHAT ARE THE PERPETUAL INVENTORY COSTING METHODS?
5. HOW IS INVENTORY TRACKED UNDER A PERPETUAL INVENTORY SYSTEM?
6. INVENTORY MANAGEMENT SOFTWARE
7. FAQS

Knowing stock balances in real time is an important way to improve trading efficiency. For a long time before the digital age, businesses used periodic inventories, usually quarterly or even annually. Today, retail employees use barcode scanners to record sales or returns at the time they are made, and also when a new batch of goods arrives at the warehouse.

By practical definition,  implementation of perpetual inventory provided by the system includes software, various barcode readers, and business processes that regulate the tracking of goods during the entire time they are in the warehouses and retail outlets of the company. Inventory management software is the main component of such a system.

Inventory management software allows you to update your inventory in real time, tracking every change. Perpetual inventory updates are especially effective when integrated with other business systems. For example, real-time inventory information is vital to finance and accounting departments.

In addition to tracking financial data, inventory software integration can be done with marketing automation systems. It quickly gives the marketing team an up-to-date picture of what sells best, on what days, and who the main customers are.

Cloud perpetual inventory management systems are very popular, for example, with data from the stores of a retail chain, and are constantly replicated from a system server installed in a data center.

Inventory management software allows you to update your inventory in real time, tracking every change. Perpetual inventory updates are especially effective when integrated with other business systems. For example, real-time inventory information is vital to finance and accounting departments.

In addition to tracking financial data, inventory software integration can be done with marketing automation systems. It quickly gives the marketing team an up-to-date picture of what sells best, on what days, and who the main customers are.

Cloud perpetual inventory management systems are very popular, for example, with data from the stores of a retail chain, and are constantly replicated from a system server installed in a data center.

While the perpetual inventory system can be used for any business size, it is best suited for fairly large companies with high sales volumes or multiple warehouses and retail locations. Small businesses often use periodic inventory systems or prefer to use Excel files for tracking inventory, because they have relatively low stock. This is also because the cost of a perpetual inventory system can be quite expensive for a small company. Instead, small businesses are usually forced to compromise between the cost of a solution and its efficiency.

Important reasons driving a business to implement a perpetual inventory system are the number of SKUs and the importance of real-time inventory information. On the other hand, implementation must be weighed against the cost of migration and ownership of the inventory management software, including IT staff costs and software vendor licensing fees.

There are other factors besides the size of a business that can deter an owner from implementing a perpetual inventory system. For example, periodic systems are more suitable for businesses offering services, or those not affected by slow inventory updates. This includes companies with an easily traceable inventory.

Many of us remember exercises from school mathematics about a pool and two pipes: through one pool it is filled and, through the other, the pool is emptied. Students counted the volume of water at different points in time. Now imagine that water meters are installed on both pipes and the volume of water in the pool can be found by simply subtracting the readings from the meters. The perpetual inventory system works in a similar way, ensuring that inventory counts are continuously updated as goods arrive in the warehouse and are sold to customers at the point of sale, including online.

The ideal business situation is a dynamic warehouse state in which all customer requests can be successfully filled while avoiding overstocking. Thanks to the perpetual inventory system with real-time data, it is possible to use algorithms for the automatic bulk ordering of goods from suppliers when supplies reach a certain level, which could be made by the EDS with the Electronic Data Interchange (EDI) feature.

The presence of a reliable data connection between the point-of-sale terminals and the central server plays an important role in updating the inventory data. Whenever a product is sold, the inventory management system immediately applies a debit to the main inventory, which becomes known across all sales channels. Barcode scanners or RFID (radio frequency identification) scanners make this process quick and convenient for staff.

Inventory tracking systems are not a universal Swiss knife, but they have many advantages and useful functions:

• Prevents the depletion of stock in normal trading conditions. Of course, if supply chains are disrupted as in a pandemic, then inventory systems become powerless to replenish goods that aren't available.
• Gives brand marketers an accurate understanding of customer preferences.
• Allows management to successfully centralize the inventory stored in different warehouses and retail outlets.
• Provides high accuracy of data on the amount of sales for the current day, week, and for other selected periods. This is helpful with forecasting as well as a historical review of sales.
• Provides valuable information for support and marketing, such as which products are returned by dissatisfied customers and which products are frequently broken during the warranty period.
• Reduces the number of total inventories that must be conducted, which periodically requires the closure of retail outlets in order to perform manual counting of the availability of goods, with subsequent adjustments made to the enterprise resource planning or ERP database.

While these are all great benefits, in real day-to-day business operations, barcode errors occur, some items drop and break in the warehouse, and theft or mistaken delivery of items to customers do occur. Even the best inventory management system cannot prevent these things from happening, but having a robust system will help you track them.

Some reviews attribute negative human factors like those listed above to the shortcomings of the perpetual inventory system, such as occasional damage to goods in the warehouse, theft, barcode scanning errors, etc. It should be recognized that these factors also apply to periodic inventory systems, so they cannot be considered specific to perpetual inventory systems.

Actual disadvantages of using a perpetual inventory system are:

• High cost compared to batch systems
• Staff requirements and the workplace culture of handling stock. In other words, employees must be diligent about tracking every item, every time.
• Inability to sell a product to a customer if it is not in the database, although the product itself could be available at the outlet.
• Disruption to the whole sales process of the company if there is a failure in the perpetual inventory system, whether attributable to the software or the data connection.

Implementing a perpetual inventory system will give your company greater access to more detailed information about how many products of each type are in stock at any given moment. Since sales are recorded as they occur, sales teams can identify which items are selling quickly, and inventory managers can reorder before the warehouse is empty. This also prevents over-ordering items that are selling slowly. Marketing teams can monitor the demand for products in real time, especially during promotions and sales events. Journal entries are made automatically in the continuous inventory system at the time of every sale.

When a buyer orders goods for a company, the perpetual inventory system makes an entry and records the transaction as it proceeds. This journal entry then reflects an increase in the quantity of goods that the company has in stock.

The entry will be:

When a salesperson in a store makes a sale to a customer, the system also records a journal entry of the sale. In a perpetual system, when a business makes a sale, two journal entries are actually required: one to record the sale and one to record the cost of the sale.

The kinds of tools needed are significantly different for perpetual and periodic inventory systems. The former requires computer software and procedures for employees to follow on how to document inventory. For periodic inventory systems, you can maintain a manual inventory count. In a perpetual system, a computer program constantly monitors the movement of products. In the periodic system, employees themselves register a change in the number of products and only at certain intervals, usually not more often than once per quarter.

Clearly, a perpetual system is more complex than a batch or periodic system, as the software and employees have to register more record entries by scanning product barcodes when entering a warehouse, moving between stores, and selling.

The most important differences between the constant and periodic systems are the:

• Cost of Goods Sold (COGS) Calculation: In a perpetual system, the software maintains a log of transactions, so you always know the COGS value. The periodic inventory system, however, calculates COGS after the physical inventory has been taken and only at the end of the reporting period, like once a quarter or per year. In the periodic system, there is no way to calculate the exact cost of the item until the end of the reporting period.
• Recording Transactions – Automatic or Manual: In a perpetual system, you simply cannot keep records manually, because you would have to keep track of thousands of transactions. Accordingly, a perpetual inventory system requires specialized software. The periodic system, by contrast, does not require any sophisticated or complex software; it is typically sufficient to make changes to an Excel or Sheets file, where you manually track your stock, using it as your periodic inventory system.
• Purchase value recording: In the perpetual system, you record the purchase value immediately. In the periodic system, you register purchases in a file, but you will not know the exact value of all purchases until a complete inventory is taken.
• Investigation into loss of goods: In a perpetual system, you can review the transaction logs and establish the moment when the number of goods changed without being purchased or written off due to damage. In this way, you can more easily investigate inventory errors. In the periodic system, these after-the-fact investigations are long and complex, and sometimes the exact cause of an inventory error or loss of goods cannot be determined in the end.

Once again, the primary difference is continually updating your accounts. In a perpetual system, the general ledger and inventory ledger updates are continuous with every transaction. In the periodic system, general ledger updates only occur after a physical count and not on a per-transaction basis.

Perpetual inventory formulas allow you to manage your stock and know when to order more inventory, as well as how much to order. The other important factor you need to know when placing an order is the lead time required.

Economic Order Quantity (EOQ) considers how much it costs to store the goods alongside the actual cost of the goods. These results allow management to manage trade more effectively and know the optimal amount of inventory to have in stock in order to minimize expenses.

What is the cost of goods sold (COGS)? The expense account grows and the cost of sales also goes up when you make any transaction in a perpetual inventory system. COGS are the direct expenses beginning with the production of goods during a chosen period. These costs include labor, materials, and parts, but do not include distribution or sales costs.

Use the figure you calculated for COGS to make purchasing decisions for the product. You can use COGS to calculate the gross margin your company has earned from the sale of a product. Gross profit is calculated as the revenue from the product minus COGS, according to this simple formula (see below). To increase gross profit, you should increase revenue or reduce the cost of goods purchased.

The FIFO method is a cost stream assumption that a company can use to estimate its inventory when the first items placed in inventory are also the first items sold. Thus, the inventory remaining at the end of the period is the last purchased or produced.

You can often find the FIFO method in supermarkets, where employees put fresher food in the back of the shelves, while food closest to the aisle has a shorter expiration date.

LIFO is a costing method that assumes the last items placed in inventory are also the first items sold. The remaining inventory at the end of the period is the oldest purchased or produced inventory.

You might say this method of counting makes little sense; otherwise, with constant restocking, the oldest products will never be sold. In most cases, you would be right, but what about the exception of goods for which the shelf life adds to their value, like selling fine wine?

In perpetual LIFO, the last cost available at the time of sale is the first that the company's software moves from the inventory account and deducts from the COGS account. This ensures that the sale price is using the most up-to-date costing method. This is especially important when market fluctuations drive the sale price of goods up or down. For example, you would want to sell your fine wine at this year’s retail price for 10-year-old wine, rather than its value from ten years ago, when it was bottled and added to inventory.

Weighted average cost (WAC) is another cost stream assumption that companies use to calculate their inventory. If the price of goods varies, then applying the WAC as the average cost of goods sold for the entire inventory is often used by accountants and reported to management and marketing.

The purpose of using the WAC is to give each SKU a baseline average selling or buying price. In a perpetual system, you can easily calculate the WAC for the average unit cost.

As defined previously, a perpetual inventory is an inventory accounting method that records the sale or purchase of inventory immediately after the transaction using cash registers with a barcode scanner and enterprise asset management software.

The perpetual inventory management system includes updating inventory immediately after each transaction. At the same time, in systems with perpetual inventory, the cost of goods sold (COGS) can be updated periodically, for example, at the end of the trading day. Otherwise, the load on the inventory tracking servers may be too high — for example, the hundreds of purchases made in the supermarket chains every minute. Yet counting each item is important to ensure accurate accounting records reflect the correct number of SKUs in a store or warehouse and are accurately registered on the books.

The inventory system can be integrated with the ERP system of the enterprise and document exchange with suppliers through EDI messaging. EDI (or electronic data interchange) is a system for transferring electronic data between contractors. Financial, commercial, and logistics information can be sent and received via EDI messages. With EDI, it is possible to automatically place orders with suppliers who will then receive an order with the number of required SKUs. The supplier will also confirm through an EDI message that the order has been accepted.

Inventory management software enables companies to efficiently manage and track inventory, purchasing, sales, and delivery. There are dozens of inventory management software vendors in the market. Choosing the most compatible software is not an easy task. It is necessary to take into account the compatibility of the software with the corporate ERP and SKB, the ecommerce platform, and other software within the corporate IT architecture.

You can search for inventory management software reviews on Google and select suitable ones for shortlisting and a more detailed evaluation. For our part, we recommend searching for "best inventory management software" reviews on the G2.com portal. There you will find ratings and vendors of both all-in-one inventory management software as well as software for specific tasks, such as keeping records in a warehouse.