Periodic Inventory System is an inventory management method in which the inventory balance is not continuously updated. Instead, the business owner calculates the inventory balance periodically, typically at the end of each accounting period. This system is used by smaller businesses or those with low complexity and less inventory.
In this article, we will explore the working of the Periodic Inventory System, including its advantages and disadvantages. We will also provide an example of how the periodic inventory system works in a small retail store, enabling you to understand the concept better. So, if you are a business owner looking for an inventory management system or an accounting student trying to comprehend the inventory systems, this article is for you.
Understanding the Basics of Periodic Inventory System
Periodic inventory system refers to a system of inventory control in which a company physically counts the inventory at specified intervals and updates its records accordingly. This method requires the company to maintain the beginning inventory balance, record purchases, record sales, and then calculate the ending inventory balance periodically.
One of the significant benefits of the periodic inventory system is that there is a low initial investment required to implement this system. Moreover, it is easier to maintain since there is less record-keeping involved. However, this method also has some drawbacks, such as the higher risk of stockouts and overstocking and difficulty in identifying the cause of inventory discrepancies. Therefore, for large and fast-growing businesses, a periodic inventory system may not be the most efficient way to manage inventory, and they may consider switching to a perpetual inventory system.
Advantages and Disadvantages of Periodic Inventory System
The periodic inventory system has both advantages and disadvantages.
One advantage is that it is less time-consuming and less expensive to maintain. With this system, the business only needs to count inventory at specific times. This saves time and resource in the long run. Another advantage is that it allows for greater flexibility in adjusting inventory levels. This can help businesses adjust quickly to changes in demand or market conditions.
However, there are also disadvantages to the periodic inventory system. One major disadvantage is that the information about inventory levels is not always up-to-date. When inventory is not counted regularly, there is a risk that the business will run out of stock or overstocked, leading to losses. Additionally, since this system relies on periodic inventory counts, there is a higher risk of errors in inventory management and record-keeping.
Implementing Periodic Inventory System in Your Business
Implementing a periodic inventory system in your business involves several steps that can help improve the efficiency of your inventory management. The first step is to establish an inventory count policy that should be followed regularly. This policy should outline the frequency of inventory counts, who should conduct them, and how they should be recorded.
Next, you need to establish a method of recording inventory levels on a periodic basis. This can be done using manual methods such as spreadsheets or through computer software programs that can help automate the process. Once you have established an inventory count policy and a method of recording inventory levels, you can begin to implement the periodic inventory system in your business. This will involve collecting data on inventory levels, valuing your inventory, and adjusting your book balances to account for any discrepancies. By implementing a periodic inventory system, you can better track your inventory, improve your cash flow management, and ultimately increase your bottom line.
Comparison between Periodic Inventory System vs. Perpetual Inventory System
The two primary methods of inventory management are the periodic inventory system and the perpetual inventory system. The periodic inventory system is a method of inventory management in which a company does not keep continuous track of its inventory levels. Instead, inventory levels are checked periodically, and the difference between the initial and final counts is used to calculate the cost of goods sold. This system is usually adopted by small businesses that do not have a lot of inventory and have limited resources to invest in inventory management.
On the other hand, the perpetual inventory system is a method of inventory management in which a company records every inventory transaction that occurs continuously. This means that inventory levels are always up-to-date, and companies can know their exact stock levels in real-time. This system is usually adopted by larger businesses, which have significant inventory levels and can afford to invest in inventory management software. While the periodic inventory system is simpler and more affordable, the perpetual inventory system provides more accurate data, enabling better decision-making and reducing the risk of stock-outs.
Importance of Accurate Inventory Valuation with Periodic System
The period inventory system has some limitations, and one of the most significant drawbacks is the lack of real-time inventory updates and valuation. As this system relies on physical stocktake to balance inventory numbers, there is a significant risk of errors, which can lead to incorrect inventory valuation. Accurate inventory valuation plays a vital role in a company’s financial reporting and decision-making processes.
Companies rely on the value of their inventory to determine their gross profit or loss. The periodic inventory system makes it challenging to get an accurate picture of inventory levels at any time. Accurate inventory valuation is essential to get a clear idea of the firms’ financial footing. An inventory valuation error can significantly impact financial ratios such as the current ratio, which depicts the company’s ability to meet its short-term financial obligations. Inaccurate valuation can also cause errors in a company’s income statement and financial reporting that could hurt its reputation with shareholders and ultimately affect its bottom line. Therefore, an accurate inventory valuation is vital for making sound business decisions.
How to Conduct Inventory Reconciliation in Periodic System
Periodic inventory system requires the company to adjust inventory records periodically instead of continuously. This means that a physical count of inventory is conducted at specific and predetermined intervals of time. Once the count is complete, the company updates its inventory records and makes adjustments where necessary.
When it comes to conducting inventory reconciliation in periodic inventory systems, there are several steps involved. Firstly, the company needs to physically count all the inventory on hand. Then, they need to reconcile this physical count with the inventory recorded in the accounting system. Any discrepancies need to be investigated and resolved. Finally, the company needs to record any adjustments in the accounting system and update the inventory balance. By conducting inventory reconciliation, the company ensures that its financial statements are accurate and reports the true value of inventory.
Real-world Examples of Periodic Inventory System in Different Industries
The periodic inventory system is widely used across various industries, from retail stores to manufacturing companies. In retail, periodic inventory involves regular stock counts and adjustments to ensure accurate inventory levels. For example, a clothing store may perform a physical inventory count at the end of each month to adjust their inventory levels in their accounting system. This helps them identify any discrepancies in stock and assists in preventing loss due to theft or damage.
In manufacturing, periodic inventory is a process where the inventory is counted at the end of a specific period. This method is useful for manufacturers who deal with a variety of parts and supplies, which can be stored for a long period before being used. For instance, a car manufacturer may use a periodic inventory method to count the number of engine components, tires, or upholstery materials held in their warehouse at the end of the month or quarter. This can help them identify any discrepancies in their inventory levels and take action to order or manufacture more components before causing delays in their production process.
Final Words
To sum up, the periodic inventory system is an inventory management method that involves taking stock of inventory at set intervals and adjusting accordingly. It is ideal for small businesses with a limited amount of inventory that does not require constant monitoring. Although this method has its benefits, it also comes with a few disadvantages such as the possibility of inaccurate stock levels and difficulty in keeping track of inventory movement.
One example of a business that uses a periodic inventory system is a bakery that bakes fresh goods every day. At the end of the day, the bakery takes stock of the unsold items and adjusts accordingly. While this method may work for some businesses, it is important to weigh the pros and cons before deciding which inventory system is best suited for the business’s needs.