There are many different ways for businesses to figure out how much their inventory is worth, and picking the one that works best for them can have effects that last for a long time.
A periodic inventory system is one of the most common and easy-to-understand ways to value something.
Startups and small businesses often use periodic inventory systems, and you may be wondering if this is the best plan for you and your business.
In the paragraphs that follow, we’ll talk about what a periodic inventory is, how it should be done, and how it can help your business.
What Is Periodic Inventory?
Periodic inventory is a way of figuring out how much stock is worth that is done at regular intervals and on a regular basis.
At the end of every period, businesses count their actual inventory and use that information to balance their general ledgers. After that, the remaining balance is added to the first day of the new term.
When using a system that does periodic reviews of inventories instead of a system that does reviews all the time, accounting procedures are different.
At the end of each year, a physical count of the company’s stock is done so that the right amount can be found for the periodic inventory.
Estimates are used by businesses as benchmarks in the middle of the year, such as in monthly and quarterly reports. Accountants do not change the inventory account in the general ledger when a company buys products with the plan to sell them later.
Instead, the purchases are taken out of the temporary account. When the New Year starts, the balance in a temporary account is always $0. At the end of the fiscal year, if there are any funds left over, the accountant will move them to a different account.
When a business buys goods, any changes that need to be made are made to a contra account in their general ledger.
A contra account is meant to be the exact opposite of the general ledger. This is because a contra account will show up on the financial statements and will balance out the balance in the account it is linked to.
Contra accounts are a type of account that includes purchases at a discount, returns on purchases, and allowances. When these accounts are added together, the total amount spent is found.
In addition to the main inventory account, companies usually keep a separate account for delivery charges as part of their system for keeping track of their stock.
They keep track of the costs of shipping items that are coming in, which are called “Freight In” or “Transportation In.” At some point in the future, the costs that are put into this account will make their inventory worth more.
What Is a Periodic Inventory System?
The periodic inventory system is a piece of software that makes it easier to do regular counts of the goods.
After a first physical inspection of the goods, companies first put the stock numbers into the program. Then, they put the data from the review into the program to make sure everything is in order.
These software programs are made to help with the way you keep track of your stock now.
You can use them to collect paper inventory lists, import stock data, and calculate the data you need to order more stock and balance the stock you have for a new period.
Also, you can use them to figure out what you need to know to order more stock. The company can export these statistics and reports to its accounting software.
The company will choose the software based on the needs of its products and its own needs.
How Periodic Inventory System works
Physically counting all the items and products a company has in stock takes a lot of time, so most businesses don’t do it very often. This usually means that it happens once a year, but it could also happen three or four times a year.
In a system called periodic, every transaction is recorded in the company’s purchase account. Based on the amount deducted from the cost of goods sold, the inventory is then managed (COGS).
But it doesn’t count items that have been lost, broken, or destroyed. It also doesn’t usually count items that have been returned.
Because of this, physical inventories are necessary because they give an accurate picture of how many physical items are kept in a store or storage facility.
After regular inventory counts are done, the records of the purchase account are changed so that they reflect an accurate financial accounting of the products based on how many of them are actually in the location.
At the end of each period, a company uses a periodic inventory system to do a physical count of its inventory to find out what’s left and how much things sold cost.
Many businesses choose monthly, quarterly, or annual accounting periods based on the needs of their products and accounting systems.
When figuring out costs, businesses look at how much inventory they had at the start, how much they had at the end, and how much they bought during that time.
This is done because firms don’t want to have to keep updating their books with the current levels of inventory and costs.
Businesses that don’t need to know exactly how much stock they have every day can benefit from doing periodic inventories.
It works well for small businesses that want to keep prices as low as possible. Companies that are growing and getting bigger often choose a perpetual inventory system, which is usually best managed with an ERP inventory module. These kinds of businesses need to keep better track of their inventory than others.
Even though it doesn’t give business decision maker’s real-time data, periodic inventory is enough for many small businesses, especially those with a small number of unique SKUs that need to be updated at the end of each month.
How do you calculate periodic inventory?
When you use the periodic inventory method, it’s easy and quick to figure out the cost of goods sold. Let’s start by going over the most important parts that are needed.
Cost of Goods Sold (COGS) = (Beginning Inventory + Cost of Inventory Purchases) – Closing Inventory
Periodic inventory formula
Periodic inventory is more of an accounting method than a calculation in and of itself, so there is no formula to use.
On the other hand, we will use the formulas to figure out how much things cost to sell and how much they cost to have on hand.
Add the amount of purchases to the beginning balance of the inventory to figure out how many the goods that are now available cost.
Cost of Goods Sold (COGS) = Cost of Goods Available – Closing Inventory
At the end of each accounting period, you will need to count up all of the items. This will be the final total of what you have in stock.
Lastly, take the ending inventory balance (sometimes called closing inventory) from the cost of goods available to get the COGS.
Cost of Goods Available = Beginning Inventory + Purchases
Advantages of using a periodic inventory system
With the help of periodic inventory, a company can keep track of both its starting inventory and its ending inventory over the course of an accounting period. This helps the company make more accurate financial statements. Here are some ways it could help your business:
Easy to implement
Because it requires fewer records than other techniques of valuation, implementing periodic inventory systems is reasonably straightforward and easy to do. In addition to that, the calculations are simple.
Great option for small business
A periodic inventory system is best for small businesses that don’t keep a lot of stock on hand.
For these kinds of businesses, a physical inventory count is quick and easy to do. It’s also a lot easier than other ways to figure out how much things sold during certain times of the year cost.
So, businesses with a high rate of inventory turnover, a large number of SKUs, the need for multichannel inventory management, or the need for real-time data are better off with other solutions.
Requires minimal information
In contrast to perpetual systems, which have to keep track of every sale and purchase in great detail, periodic systems do not have to keep track of each transaction.
In the field of ecommerce bookkeeping, periodic inventory systems are pretty simple. For small inventories, they can use only a few data points to figure out the cost of items sold and available. This is possible because these systems don’t need much information.