Unlike regular inventory counts that mostly focus on the number of items in stock and their projected levels, periodic inventory systems serve a financial purpose that takes valuation into account. The results of a periodic inventory count are used to balance a company’s ledger at the end of an accounting or bookkeeping period. This balance is applied at the start of the subsequent period. When adequate periodic inventory systems are in place, businesses with high inventory counts can figure out the best pricing and selling practices to boost their bottom line.
How Periodic Inventory Systems Work
If you run an e-commerce business that does not require you to physically keep items in stock, going the periodic inventory route is not necessary. In this case, you can get by with perpetual systems included in many point-of-sale software solutions, which track items on a real-time basis. The periodic style of inventory management has been around for a long time, and it relies on the traditional methods of physically counting items while taking into consideration the cost of goods sold (COGS) as well as other accounting principles.
When a periodic inventory system is used, business owners can get a more realistic picture of how their selling efforts are paying off or not. For this reason, periodic inventory systems are recommended to companies that manage stockrooms or warehouses. If you are mostly a drop-shipper running your business on an e-commerce platform such as Shopify, your retail partners handle all the physical inventory for you. Thus, you will need to track sales and marketing efforts in lieu of having to worry about inventory.
The Benefits of Periodic Inventory Systems
With the periodic inventory method, transactions are handled in a way that allows for more strict accounting. For example, the items you purchase to keep in stock are recorded as costs placed under the purchase account category. When you sell an item, you record a single entry for the sales transaction. When a customer returns a sale, only the actual return is taken into account and not the cost because that will be determined at the end of the period, which for many business owners happens on a quarterly basis. Perpetual inventory systems will default to double entry bookkeeping when goods are sold or returned. Moreover, only the inventory is updated and not the various purchase, returns, discount, and allowance accounts.
Periodic Inventory System Example
Let’s say you spot a great turnkey deal to take over a footwear store with an inventory of shoes and accessories that is worth $100,000. Everyone who operates in retail footwear knows that physical stock counts are crucial because this sector is notorious for shrinkage. As much as shoe store managers try to keep store shelves and the stockroom organized, they will run into issues related to misplaced items, returns, shoplifting, incorrect applications of discounts, and more. Physical stock counts are absolutely necessary because they can shine a light on shrinkage and how to mitigate it as much as possible. Since you will be doing this in your new shoe store, you are already satisfying a significant aspect of the periodic inventory method.
We’ll call your new store Happy Feet in this example of a periodic inventory system. The applicable cost of goods sold formula is in the image that follows.
As mentioned above, you inherited $100,000 worth of stock. Let’s say you purchased an additional $120,000 in the first quarter of operations, and the final stock count came up to $80,000. In this case:
When You Should Choose the Periodic Inventory Systems Method
As previously mentioned, any situation whereby your business absolutely needs to conduct physical stock counts will be served well by the periodic inventory method. Any retail business that is busy will benefit from this inventory method, and this applies to both brick-and-mortar as well as e-commerce stores. Imagine a busy auto repair shop or a fashion boutique where members of the sales staff are trained to encourage multiple purchases through discounts.
Accounting and forecasting are definitely easier when a periodic inventory system is used. We can say this with confidence because we have seen business owners who believe that the real-time perpetual inventory system provided by POS systems will completely automate their inventory and accounting systems. What these company owners are not aware of is that the full implementation of such systems is not so easy. First of all, every item in stock, including goods and parts, must have a proper bar or QR code. This means that a database must be set up along with a scanning system. The next step involves training all staff members to handle goods in a way that they are properly scanned with regard to sales, discounts, allowances, and returns.
Shrinkage will happen whether you use a real-time perpetual inventory system complete with code scanning or a periodic system with manual count. For this reason, vendors of POS solutions often tell their clients to reconcile their inventory systems with manual counting for the purpose of figuring out shrinkage.
Implementation of a periodic inventory system is far easier, particularly when you go over the procedures with your accountant. This is a system that goes hand-in-hand with traditional bookkeeping, which can also be augmented with a POS application and reviewed by accounting professionals working remotely. In terms of execution and understanding, we highly recommend periodic inventory because the reports and formulas are highly intuitive and realistic. In our experience, the myriad analytic scenarios generated by perpetual inventory systems can be confusing for many small business owners.
If you operate one or two stores and a couple of warehouses, this system is for you. If you have multiple locations and multiple stock rooms, you will need a customised system that includes elements of real-time inventory accounting.
Learn More About the Periodic Inventory System That is Right for You
At Fusion CPA, we are ready to discuss the inventory system that will be more suitable to your business. Do not feel disheartened by the physical count requirements of periodic inventory accounting. You can still use bar codes and POS scanning systems to help you in this regard. What is important in this system is for you to ascertain your stock count and see the actual value of items you have on hand. Once you go through a couple of quarters and evaluate the inventory reports, you will have a good idea of how to adjust your retail strategy. Get in touch with our office today to discuss your inventory accounting options.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.