What is a perpetual inventory system? (And how to use it)

By Indeed Editorial Team

Published 26 September 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Monitoring and managing inventory is essential for any business. Good inventory management ensures companies have enough stock to meet customer demand while not overpaying on storage costs or risking making losses on unsold stock. Learning about perpetual inventory can allow you to help your employer improve its inventory management by tracking the business's stock in real time. In this article, we define a perpetual inventory system, explain how it works, look at how it differs from a traditional periodic inventory system, outline how to use a perpetual system and review its benefits.

What is a perpetual inventory system?

A perpetual inventory system is a way of managing a business's inventory in real time. These systems use automated technology to track stock inventory and update inventory data when a company sells or receives new stock. This means the inventory data changes in real time with each transaction and offers greater accuracy when compared to traditional inventory management systems. When using a perpetual system, employees can generate an accurate stock report at any point to find out how much stock is currently available.

Related: An inventory system guide (with tips for choosing one)

How do perpetual systems work?

Perpetual systems work by automatically updating inventory counts and stock data every time a transaction takes place. This includes when a business sells its stock and acquires new stock alongside other stock losses, such as theft or damage. Each perpetual system may work slightly differently, but most utilise similar technology to keep accurate stock records. Point-of-sale system updates are a vital element of these systems, which occur every time employees register a sale using the POS system. Often, barcodes or radio-frequency identification (RFID) scanners automate this process.

This inventory management system automatically updates the cost of the goods sold (COGS) in the inventory data and updates reorder points as sales increase or decrease to ensure stock levels are optimal at all times. When a company reaches these reorder points, it automatically reorders new stock and sends it to the supplier. Employees then scan the products they receive into the business's inventory using warehouse management software. This updates the inventory dashboard and stock data to make these items available for purchase.

Related: What is inventory management? (Definitions and applications)

Perpetual vs periodic inventory systems

A periodic system counts and tracks inventory periodically, usually every time a business makes a sale. Periodic inventory systems don't work in real time because employees manually update them at regular intervals. This often means periodic inventory systems are more labour-intensive, less flexible and slower to use when compared to modern perpetual systems. Periodic inventory systems also struggle when discrepancies arise because it may be challenging to identify when these discrepancies occurred. In contrast, discrepancies are easier to identify in perpetual systems due to recording stock waste or theft in the system's records.

Related: Calculating finished goods inventory formula (with example)

How to use a perpetual system

Find out how to use a perpetual system by following these steps:

1. Consider the business's requirements

To use a perpetual inventory management system, start by identifying the business's needs. Choose a perpetual system that meets the business's requirements and can successfully integrate with the company's existing systems. To do this, consider the volume of stock the business sells, how often the company acquires new stock and how much the business spends on storage.

Related: What is perfectly elastic demand? (And how to calculate it)

2. Choose the appropriate software to use

Once you have a firm idea of the business's requirements, choose the best perpetual inventory management software to help the company meet its goals. The software you choose may have a significant impact on a business's output, so it's essential to research different systems and consider the pros and cons of each. Some systems may offer lower price points but suffer from more inaccuracies or offer less technical support. If you're new to perpetual inventory management systems, working with a supplier to choose a system that meets the company's budget and needs, while offering adequate technical support, is advisable.

Related: A complete guide to different types of software programs

3. Migrate the company's inventory

After you choose and install the most suitable perpetual inventory software for the business, migrate the company's existing inventory data to the new system. Many inventory software companies offer training sessions to help companies get started with their products. Also, IT solutions firms can often help businesses to move their existing systems to the new software. During the migration process, note the particular aspects of the software that are complex or challenging to use and consider the training you can offer to help existing staff members and new recruits to overcome these issues.

Related: What is inventory control? (Definition, types and guide)

What formulas do perpetual systems use?

Perpetual inventory management systems use formulas to calculate stock data and recalculate crucial figures, such as reorder points. If your employer uses perpetual inventory software, it automates these calculations for you, but some small businesses may conduct these calculations manually to reduce costs or pilot the perpetual inventory method before they invest in the software. Below are some examples of the formulas used in perpetual systems:

COGS

COGS refers to the cost of producing the goods that a company sells. This metric is crucial to determine for calculating a business's optimum inventory levels and effectively using a perpetual inventory management system. The simplest way to calculate COGS is to apply this formula:

COGS = Starting inventory + purchases - ending inventory

Related: What is inventory accounting and its costing methods?

EOQ

Economic order quantity, or EOQ, is the optimal order quantity for any business. Buying stock by using this metric minimises the cost of reordering and reduces the amount of warehouse space that businesses require, while also reducing the risk of demand exceeding stock levels. The formula to calculate EOQ is:

EOQ = √(2SD) / H

Where 'S' refers to the setup costs per order, 'D' is the demand rate and 'H' refers to the holding costs per unit per year.

FIFO and LIFO

First in, first out (FIFO) is a method of valuing inventory based on the principle of selling the goods purchased first before the goods the business purchases later. The FIFO method prevents old stock from sitting in a warehouse for a long time and means when product updates take place, the company sells old stock before new stock. To calculate FIFO, or the cost of goods sold using the FIFO method, calculate the cost of the business's oldest inventory and multiply that by the amount of inventory sold.

Last in, first out (LIFO) is a method of valuing inventory based on the principle that the business sells the products it most recently purchased first. It's possible to calculate the cost of goods using the LIFO method by determining the cost of the business's most recent inventory and multiplying this by the amount of inventory sold.

Perpetual system benefits

There are many advantages to using a perpetual system to manage a business's stock in real time. E-commerce businesses of all sizes may find that using a perpetual inventory management system offers them greater flexibility and more accuracy while also reducing the time spent monitoring and recording inventory data. Some of the most significant benefits of using a perpetual system to monitor inventory include:

  • Records data in real-time: Perpetual systems record inventory data in real-time. This means the stock data is always accurate.

  • Offers detailed records: Perpetual systems automatically update inventory records every time a business acquires or sells stock and track movements within a business's supply chain. This results in clear inventory records that may help to identify bottlenecks in the supply chain.

  • Lowers costs: Using a perpetual inventory management system may help businesses to lower their costs. They do this by reducing the cost of holding more stock and replenishing inventory.

  • Creates automatic end-of-year calculations: Perpetual systems automatically calculate an end-of-year inventory balance. This is beneficial when filing tax and accounting records.

  • Forecasts stock demand accurately: Perpetual inventory management systems are capable of accurately forecasting future stock demand. They can do this due to the accurate data they offer concerning demand levels at different times.

Related:

  • A guide to inventory manager responsibilities (plus salary)


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