Uncovering the power of perpetual inventory management systems
Next to cash flow, effective management of a company’s inventory (or stockholding) in real time, is vital to being able to make smart commercial decisions. In the same way that businesses can get into trouble by not knowing their numbers, so they can over or underspend by not knowing their stock.
In a perpetual inventory management system, the amount of merchandise and the cost of goods sold are constantly updated with each sale and purchase transaction. A business using this system can continually update its inventory records to account for any changes in inventory levels such as any bought or received items, goods sold or returned, goods moved to other locations, items picked from inventory for use in the production process or items scrapped. If knowledge is power, then perpetual inventory management is powerful.
These systems have the advantage over manual processes by providing up-to-date inventory balance information and reducing the level of physical inventory counts required. However, the calculated inventory levels derived by a perpetual inventory system may gradually diverge from actual inventory levels over time. (This can be due to unrecorded transactions or theft, so it is prudent to periodically compare book balances to actual on-hand quantities, and adjust the levels where necessary.) Perpetual inventory systems provide the business owner with a record of what is sold, where it was sold from, when it was sold, and for what price it was sold. This also allows businesses with more than one location to have a centralised inventory management system.
The smartest business decisions are made from real time information
The alternative to a perpetual inventory management system is a periodic system where merchandise inventory and the cost of goods sold are not updated continuously. Here, purchases are recorded in a separate purchases account and each sale transaction is recorded via a single journal entry. This means that the ‘cost of goods sold’ account does not exist during the accounting period and is instead determined at the end of the period via a closing entry. This is akin to only looking at your financials retrospectively when it is too late to do anything about them.
Conversely, in a perpetual inventory system, changes to stock levels are recorded in real time, when inventory is purchased and when it is sold. This provides businesses with the ability to generate reports that can be used to immediately identify any inventory items that are running low or are overstocked. The major advantage of doing a periodic inventory count is to determine how much inventory has been lost, stolen, or subject to spoilage. Even with a perpetual inventory management system, the company still needs to shut down at least annually to do a periodic, or manual, inventory count.
Modern technology makes inventory management manageable…
Perpetual inventory systems are by far the preferred method for tracking inventory, and if properly managed, they can yield reasonably accurate results on an on-going basis. The system works best when coupled with a computer database of inventory quantities and product locations, which is updated in real time by the warehouse staff using wireless bar code scanners, or by sales clerks using point of sale terminals. The scanned data tells the business owner exactly what stock should be on hand.
The main advantage of utilising a perpetual inventory management system is that it helps to prevent a business from running out of stock, mitigating the risk of losing customers to competitors who are able to supply the product.