The periodic inventory system is an inventory managing method, which determines the inventory count at the end of a period. The period could be three days, a week, a month, or a year.
Companies count the inventory physically. It takes a lot of effort and time. To save energy, companies took longer periods in counting their inventory, like three or four times per year.
The Importance of an Inventory System
Knowing your inventory is the first step to knowing your business. The market is a battlefield. You continuously wage war on your enemies. The enemies are your competitors and the demand of your customers. The victory is you gaining a massive profit while making your customers happy.
It’s essential for every kind of business, especially for product-based companies, like manufacturers and retail stores. Even for service-based companies, the inventory system is useful for keeping track of consumables and office equipment.
You can use the information gained from the periodic inventory system to decide the future, Such as:
- Adjust the amount of goods purchase to meet customers’ demands.
- Calculate revenue.
- Review your storage facility.
- Review supply and demand patterns to maximize profit.
How Does Periodic Inventory System Work?
To do a periodic inventory check, follow these steps.
Determine Beginning inventory
First, you have to determine your current asset, the beginning inventory. How much do I currently have? Are the goods 100% shippable? You might want to double-check for broken items.
You restock your goods by buying them from somewhere or create one yourself. All purchases should be going into your purchases account. Make sure you know how much stuff you bought and how much did you pay for it.
Sell the Goods
You sell the goods and earn a profit. You must count the revenue generated from total sales. Consider advertising your goods so they can sell better. Treat your customers with the utmost care and respect.
Do a Physical Inventory Check
You have to choose intervals in which you do a physical check. A month, three months, a year, three years, you choose. It usually depends on how big your inventory. Bigger inventory takes more effort, thus, favoring longer intervals.
You simply go to your storage facility and count all your goods. You can use QR codes, barcodes and scanners to make the job more efficient. We will call the result as closing inventory.
Do the Math
Our primary objective is to determine the cost of goods sold, and determine the change of inventory at each interval. The formula is:
$$Closing\: Inventory = Beginning\: Inventory + Purchases - Cost\: of\: Goods\: Sold$$
However, there are some loose ends. This calculation does not include damaged goods, lost goods, broken goods, and returned goods. That’s why you should always report missing, broken, or returned goods as soon as you encounter them for inventory precaution.
You own a retail store that uses six months of periodic inventory checking system. It’s January, and you currently have 50 packs of toilet papers. Each pack costs $5. So, you have $250 in your beginning inventory.
Then in February, you bought 100 packs of toilet papers. Each pack also costs $5. That’s $500 in total. We put that $500 on a purchase account.
In March, toilet paper prices suddenly rise. You sold 120 packs of toilet paper for $10 each. That’s a total of $1200.
June happens, time for a trip to your storage facility. You count all your precious toilet papers. You found a total sum of 30 packs of toilet papers. Since you bought it at a mere $5, the closing inventory is 30×5, which equals to $150.
Now let’s count the cost of goods sold. Using the formula listed above, we have this function:
$250 + $500 – Cost of Goods Sold = $150
Now we do some algebra magic to rearrange the function to be like this:
$250 + $500 – $150 = Cost of Goods Sold
The cost of goods sold is $600.
The beginning inventory is $250.
The final inventory is $150.
The inventory difference for January to June interval is -$100.
The Advantages of Periodic Inventory System
A periodic inventory system lets you do fewer steps. You do less math, use less paper, and you can use your time and thoughts for everything else.
You only need to count your inventory at a regular interval. Sure, you might want to buy some barcode stickers and a barcode scanner. But they are much cheaper than running a sophisticated computer system that monitors your inventory at all times.
The Disadvantages of Periodic Inventory System
Since the main objective is to count the cost of goods sold and the closing inventory, we need to wait until the physical check is finished. Depending on the amount and goods type, this process could take days, weeks, or even months.
Since the update of the periodic inventory system can only happen after a specific interval, tracking a fast-moving commodity could be hard. In the garment industry, there are a lot of shirt styles for different seasons.
If the inventory is updated in half a year, therefore slower than seasons went, it will impact on the garment prices; thus, garment sales. A faster inventory system enables companies to react faster to supply and demand of the market.
The periodic inventory system is a way to track your inventory. It determines the inventory count at the end of a period. The period could be three days, a week, a month, or a year. The cycle of the periodic inventory system consists of 5 steps.
Determining beginning inventory, determine purchases, sell the goods, do a physical inventory check, and finally doing the math to find the cost of goods sold. The advantages of the periodic inventory system are relatively cheap cost and simplicity.
The disadvantages of periodic inventory systems are the slow process and less fidelity in inventory updating. This system is better suited for small businesses with fewer goods or slow-moving goods with less variety.