What is periodic inventory system? How it works and benefits

In the realm of business operations, managing inventory is a critical component for success. One approach, known as the periodic inventory system, is an accounting method embraced by many, particularly small businesses. This system involves tracking inventory and cost of goods sold (COGS) at specific intervals.

Employing a periodic inventory system can offer several benefits, making it a popular choice for businesses looking to simplify their inventory management process. In this article, we'll delve into how this system works and explore its various advantages.

What Is Periodic Inventory System?

The periodic inventory system is an accounting method where inventory is not updated continuously but at set periods. Typically, physical inventory counts are conducted monthly, quarterly, or annually to ascertain stock levels and calculate the cost of goods sold (COGS).

This method is especially beneficial for small businesses that have a lower volume of transactions or fewer stock-keeping units (SKUs). Since the process does not require sophisticated tracking systems, it is cost-effective and relatively straightforward to implement.

Under this system, purchases made during the period are recorded in a 'Purchases' account. At the end of the period, a physical count determines the ending inventory's value, which is used to calculate COGS. The simplicity of this approach is what often attracts small businesses.

How Does Periodic Inventory Work?

Understanding the mechanics of the periodic inventory system begins with the inventory purchase. When inventory is bought, the expenditure is added to a purchase account, which accumulates over the accounting period. The physical inventory count then becomes an essential activity to determine the ending inventory value.

Once the period concludes, the physical inventory count is used to calculate the ending inventory. The cost of goods available for sale is determined by adding the beginning inventory to the purchases. COGS is then calculated by subtracting the ending inventory from the goods available for sale.

The periodic system does not track each sale or purchase of individual items throughout the period. Instead, the system provides a snapshot of the inventory at the end of each period, which is then used for accounting and analysis purposes.

What Are The Advantages Of A Periodic Inventory System?

• Cost Efficiency: Ideal for businesses with limited budgets, as it does not require expensive inventory tracking technology.
• Simplicity: The system's straightforward nature makes it easy to implement, particularly for businesses that do not have complex inventory needs.
• Flexibility: Companies can choose the frequency of their inventory counts based on their specific needs and resources.
• Audit Trail: Accumulating purchases in a separate account creates a clear record, which is beneficial during audits or financial reviews.

These advantages make the periodic inventory system a compelling option for many small businesses. It allows for a balance between maintaining inventory records and managing costs.

What Is The Periodic Inventory System Formula?

To determine COGS under the periodic inventory system, the following formula is used:

COGS = Beginning Inventory + Purchases - Ending Inventory

This calculation provides the cost of inventory sold during the period. The resulting figure is crucial for financial statements, impacting the gross profit and net income of a business.

It is essential for businesses using this system to conduct accurate physical counts to ensure that the ending inventory value is correct. Any inaccuracies can result in misleading financial data.

Periodic Inventory System Vs Perpetual Inventory System

While the periodic system relies on interval-based counts, the perpetual inventory system updates inventory records in real-time with each purchase and sale. Each has its own set of advantages:

• Periodic Inventory:
  • Lower cost and complexity.
  • Suitable for businesses with less frequent inventory transactions or smaller product ranges.
  • Requires physical counts at designated intervals.
• Perpetual Inventory:
  • Real-time inventory tracking and data.
  • More accurate inventory management, reducing the likelihood of stockouts or overstocking.
  • Typically requires integrated inventory management software.

Choosing between these two systems depends on the specific needs and resources of a business.

Alternatives To A Periodic Inventory System

For businesses that find the periodic system too simplistic or that require more detailed inventory management, alternatives are available:

• Just-In-Time (JIT) Inventory: Reduces inventory holding costs by ordering stock in line with customer demand.
• ABC Analysis: Classifies inventory into three categories to prioritize management efforts.
• Dropshipping: Eliminates the need to hold inventory altogether by shipping products directly from the supplier to the customer.

These alternatives can offer more sophisticated solutions but often come at a higher cost or with additional complexities.

Frequently Asked Questions About Periodic Inventory Systems

What Are The Benefits Of Periodic Inventory System?

The periodic inventory system offers several benefits, such as cost savings due to the lack of need for advanced tracking systems, and simplicity, making it accessible for businesses with limited accounting resources. Additionally, it allows for flexibility in inventory count schedules, which can be adjusted based on the specific needs of the business.

How Does Periodic Inventory Work?

Periodic inventory works by accumulating inventory purchases in a specified account throughout an accounting period. At the end of this period, a physical count of the inventory is conducted to determine the ending inventory value and subsequently calculate the cost of goods sold.

Which Of The Following Is A Benefit A Periodic Inventory System?

A key benefit of the periodic inventory system is its low cost and ease of implementation, especially for small businesses with simpler inventory management needs.

What Is Inventory System And Its Benefits?

An inventory system is a process or software used to track and manage the goods a business holds. Its benefits include improved accuracy in order fulfillment, better cash flow management due to optimized stock levels, and insights into sales trends and inventory turnover.

In conclusion, the periodic inventory system offers a practical solution for many businesses, balancing the need to manage inventory with the resources available. While alternatives provide more detailed tracking, the periodic system remains a reliable option for those seeking simplicity and cost-effectiveness.

For a visual explanation of how inventory systems work, including the periodic inventory system, watch the following video:

If you want to know other articles similar to What is periodic inventory system? How it works and benefits You can visit the category Reviews.