Inventory Management: A Comprehensive Understanding of Periodic and Perpetual Inventory



Inventory is a vital element in any business, be it a wholesale store, manufacturing enterprise, or restaurant. It involves tracking all the goods and materials used in the business, ensuring that there are adequate quantities of everything. There are two primary types of inventory: periodic and perpetual. Both types have their own advantages and disadvantages, and a proper understanding of these concepts can help businesses achieve optimal profitability.

Categories of Inventory

There are three main types of inventory in any business operation: raw inventory, work-in-progress inventory, and finished inventory. Raw inventory includes the raw materials that have been purchased but not yet used in production. Work-in-progress inventory includes the materials that have already been used in the production process but have not yet been finished. Finally, finished inventory includes the products that have been manufactured and are ready for sale.

Periodic Inventory vs. Perpetual Inventory

In periodic inventory, inventory records are updated at the end of a particular period, which could be daily, weekly, monthly, or even yearly. In this type of inventory, companies have to conduct physical inventory audits to determine the amount of remaining goods.

On the other hand, in perpetual inventory, inventory records are updated in real time with every purchase or sale transaction. This type of inventory relies on information technology to accurately track goods and increases operational efficiency.

Challenges of Perpetual Inventory

Perpetual inventory, despite its numerous advantages, is not without challenges. Implementing it correctly requires the use of advanced technology to effectively track operations and accurately follow goods. These systems can be costly for small to medium-sized businesses trying to stay competitive in a market. In addition to the cost, dealing with inventory errors, theft, or damage in real-time can be difficult, especially in environments dealing with large quantities of goods. Perpetual inventory also requires continual system and software updates to maintain data accuracy, which can be a challenge for companies lacking the necessary resources.

Challenges of Periodic Inventory

The challenges associated with the periodic inventory system are several. First, periodic inventory may require a significant effort in certain cases, especially if the company is dealing with large quantities of goods. Periodic inventory may also result in business operations stopping during the inventory period, which can lead to financial losses. In addition, it can be difficult to detect errors and embezzlement in the inventory until the next periodic inventory is performed, exposing the company to the risk of loss.

Read more: Inventory Management: Techniques And Types Explained. EBITDA: Calculation, Meaning, And Traits.

Here is an example of what these transactions might look like in a real-world business context:

Purchasing Goods

If a business purchases goods to add to its inventory, the journal entry in their books might look like this:



This entry signifies that $5000 worth of goods was added to inventory, and this amount is owed to suppliers (recorded as Accounts Payable).

Selling Goods

When the business sells goods, two transactions are generally recorded – one for the revenue from the sale, and another for the cost of the goods sold (COGS):



The first entry records the sales revenue that is expected to be received (Accounts Receivable), while the second entry records the COGS and decreases the Inventory.

Sales Returns

If a customer returns goods that were previously sold, the entries would look like this:



The Sales Returns account records the amount of sales that was returned, reducing the Accounts Receivable. The second entry increases the Inventory for the returned goods and reduces the COGS.

Paying for Expenses

If the business incurs expenses related to the sale (like delivery charges), it might record:



This entry increases the Delivery Expense account and decreases the Cash account.

Read more: Debit vs. Credit: Everything You Need to Know.

Best Practices for Inventory Management

Effective inventory management requires good planning, organization, and control. First, companies need to understand demand and its forecasts to ensure inventory aligns with demand. In addition, the right inventory management tools, such as inventory systems, should be used to ensure continuous inventory updates and avoid inventory shortages or excesses. Lastly, companies should invest in training workers on best inventory management practices to achieve the highest effectiveness in inventory operations.

The Technological Role in Inventory Management: Using Software in Inventory Management

In the modern digital world, software has radically changed how inventory management is conducted.

• Software allows for instant tracking of current inventory and continuous data updates.
• Software provides detailed reports that aid in analyzing and improving inventory processes.
• Wafeq accounting software not only allows for inventory tracking but also provides a powerful suite of tools that help companies maximize their inventory-related data.
• Sales analytics, profitability, and cost analytics can be used by companies to improve processes and increase efficiency.

Inventory and Profitability: The Relationship between Inventory Management and Profitability in Business.

Effective inventory management plays a crucial role in achieving profitability in business. It preserves financial resources by minimizing unnecessary inventory costs, such as excess storage costs and losses resulting from damaged or surplus products. By ensuring the availability of required products at the time of demand, it can also improve customer satisfaction and increase sales. Businesses that manage their inventory well have a greater capacity to adapt to market changes and customer requirements, thereby increasing their profitability.

Conclusion

In general, inventory management is a vitally important task for any kind of business. Properly managing inventory can provide companies with financial stability and the ability to predict profitability. However, it requires dedication and attention to detail, especially when dealing with large quantities of goods and multiple transactions.

Using technology and software like Wafeq can help to simplify this process and make it more accurate and efficient. But even with the use of software, it's essential that the right individuals have the skills and knowledge necessary to effectively manage inventory.

The challenges facing inventory management can be daunting, but with good practices and the right tools, companies can overcome these challenges and ensure that their warehouses operate efficiently and cost-effectively. Building an effective inventory system can help reduce expenses and increase profits, which benefits businesses in the long run.Use Wafeq - the accounting system that allows you to manage your inventory, payroll, and more.