Get this - U.S. businesses carried $2,069.5 billion of inventory through July of 2021. That’s a 16.3% compared to 2020 when inventories were depleted during the early days of COVID. Further, business-to-sales ratio for inventory is 1.25, the lowest point since 2012 and reflective of the boom caused by pent-up demand.
It’s no doubt that raw materials and components account for a large portion of manufacturing costs, but not all inventory is treated equally. Manufacturers must strategically choose periodic or perpetual inventory accounting to manage this material efficiently and keep from adding unnecessary internal costs.
But which accounting system makes sense for a manufacturer? And what’s the difference between a periodic inventory system vs. a perpetual inventory system? The answer lies in the methodology, and today, the distinction is closely tied to software capability.
What Is Periodic Inventory?
Periodic inventory uses occasional inventory counts to determine the level of inventory on hand. The measurement period can be any number of set timeframes such as monthly, quarterly, or even yearly. Many companies use quarterly internal inventories throughout the year with an audited inventory at the end of the year to validate their numbers. The final measurements against the cost of goods sold (COGS) can impact financial statements, taxes, stock reporting to investors, and more.
COGS is a crucial component in the periodic inventory equation. Once COGS is completed, subtraction of COGS from sales for the measured period equals gross margins. This formula means that inventory is a direct component of margins. The formula for this is:
Inventory Beginning Balance + Purchases – Ending Inventory Cost = Cost of Goods Sold
What Is Perpetual Inventory?
Perpetual inventory systems came about in the technological age as computers allowed for tighter tracking of inventory levels. In a perpetual system, digital technology is used to update the inventory as each sale occurs. These adjustments are made automatically, so decision-makers and managers always know the level of inventory on hand.
COGS is also adjusted for each sale. This means that perpetual inventory and periodic inventory are counting the same way to arrive at gross margin. Still, the perpetual inventory method is more accurate and more reflective of day-to-day reality.
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