Inventory management is critical to your business’s ability to meet customer demand. A perpetual inventory system provides real-time tracking of stock down to the SKU level to streamline your operations and improve efficiency.
Read on to learn how these systems work and why they’re essential for you to stay in stock, manage costs, and maximize profitability.
What is a perpetual inventory system?
A perpetual inventory system is an advanced inventory management method of continuously tracking and recording stock levels in real time. As items are received or sold, the perpetual system automatically updates SKU quantities and inventory balance sheets for visibility into multiple facets of your business, including inventory turnover ratios and optimal reorder quantities. At a higher level, these insights also let you manage cost of goods sold (COGS) and cash flow.
What is perpetual inventory?
Perpetual inventory is the accounting method that aligns with your system. When items are sold, sales values are recorded as credits to your inventory balance sheet. This lets you see how sales cover and surpass the cost of goods sold to deliver profit. Your perpetual inventory system provides this accounting automatically.
Key features of perpetual inventory systems
A typical perpetual inventory system includes the following features:
- Real-time inventory tracking at the order and SKU levels
- Connectivity across barcodes, scanners, points of sale, and warehouse management systems (WMS)
- Ledger-style information detailing cost of goods sold, sales by order, SKU, and remaining stock quantities
- Notifications and reporting to drive insights, strategy, and decisions
- User configurations to customize systems for your unique business needs.
Why do I need a perpetual inventory system?
A perpetual inventory system is generally the most effective way to manage inventory and accounting, especially if you use an omnichannel fulfillment strategy where you fulfill orders across sales channels from a unified stock. That’s because the ability to track inventory across multiple locations and sales channels is crucial to controlling cost of goods sold and meeting customer demand.
Without a real-time system,you’d have to do a physical count of inventory and compare it against sales and accounting documentation. And that’s actually what major retailers did for a long time prior to digitization.
That method is called a periodic inventory system. Some smaller businesses may still use it because they can’t justify the costs of advanced software.
For the most part, though, ecommerce requires real-time data. By automating recordkeeping, you’re free to focus on other areas of your business, like cash management and marketability.
How does a perpetual inventory system work?
A perpetual inventory system follows your order-to-cash cycle. In the order-to-cash cycle, you place orders with your supplier, receive items at your warehouses, sell items on your website or other channels, and fulfill your orders to close out the cash as profit or reinvestment in growth.
During each stage of order-to-cash, your perpetual inventory system has its own jobs to do. Here’s how it works.
Supply order management
Since your perpetual system is continuously receiving data from your sales channels and warehouse management system (WMS), it can report on inventory levels, sales trends, cost of goods sold, and profit. Some systems can use this data to adjust reorder points for you, signaling when it’s time to replenish stock or automating purchase orders to send to suppliers.
Warehouse receiving
During receiving, warehouse staff scan barcodes on boxes or other containers that hold multiple SKUs. The barcodes contain information about which SKUs are part of the received shipment, which updates your SKU quantities in bulk in your perpetual inventory system.
Point of sale
Sales are recorded when a customer pays at the point of sale (POS) on your website or other channels. Your perpetual inventory system reduces your inventory by the quantity sold, even though the order hasn’t been fulfilled yet. This ensures product availability is accurate on your sales channels so customers aren’t disappointed by stockouts.
Customer order fulfillment
During fulfillment, warehouse staff scan items to pick and pack for customer orders. This information also updates your perpetual inventory system and financial data at the same time.
What is a periodic inventory system?
A periodic inventory system is a separate method of inventory tracking and management. Under this system, inventory and accounting are updated periodically instead of perpetually. A periodic system typically uses physical inventory counts to validate purchase orders, stock value, and sales data.
Once you have a physical inventory count, you can use the information to correct discrepancies at the SKU level and validate profits.
Why do I need a periodic inventory system?
A periodic inventory system is commonly used by smaller businesses with less complex inventory needs, but you could also use it to further validate the automated information in your perpetual inventory system.
This could be useful if you have gaps between your physical inventory count and digitized data in your inventory system. For example, when a warehouse receives and scans a shipment, the barcode tells the system what and how many SKUs are in each box. But that doesn’t mean the information reflects what’s really in the box.
Shortages and damages can happen. If they aren’t caught during receiving, your data is inaccurate. Periodic inventory systems can help surface these discrepancies. You can use that information to reconcile inventory data or take it back to suppliers or carriers to improve services or negotiate prices.
Differences between perpetual and periodic inventory systems
A perpetual system and a periodic system represent two distinct approaches to inventory management and accounting. The primary distinctions relate to the timing and methods of how you record transactions.
A perpetual inventory system tracks stock information in real-time as items are received and sold. Data is automatically recorded by digitized tools, like your website’s point-of-sale and WMS, providing an accurate, up-to-date view of current inventory. This lets perpetual systems align with other business cycles automatically.
In contrast, periodic inventory systems rely on an occasional physical count to measure inventory levels, usually at the end of an accounting period. These systems calculate information all at once based on the period’s beginning inventory, purchases, and ending inventory.
That means data from a periodic inventory system lags, causing you to miss out on the day-to-day data and insights that let you meet ecommerce demand.
Another big difference is that periodic inventory systems require you to plan an inventory count event that allocates staff and other resources away from your usual workflows. Downstream, your buyers, inventory managers, accountants, and other staff may have to put in a similar effort on the financial side. Having inventory management software handle this for you could go a long way toward keeping your overall inventory cost at an acceptable level.
Other inventory management methods
Within your perpetual inventory system, you can choose from various methods to track and value inventory. Most ecommerce companies use first in, first out (FIFO), although some businesses may benefit financially from last in, first out (LIFO). These approaches are called cost flow assumptions because they guide how you track costs against inventory turnover.
First in, first out
FIFO is where the oldest inventory items are sold first. In a warehouse, that means you place new batches of stock behind existing stock or in a completely separate area, so the oldest items are picked and packed first.
Businesses use this method because it can simplify tracking inventory. When items stay in your warehouse for too long, their storage costs increase, reducing gross profit and margins. With FIFO, you can improve inventory turnover ratios by keeping products moving.
It can also improve aging metrics in your inventory reporting because items move through your stock in consistent cycles. This can support more reliable profit calculations or, in times of inflation, more favorable profit margins if an earlier cost of goods sold is lower than the current inventory cost against stable or increased customer prices. This benefit has a caveat, though. When forecasting, you may miscalculate future orders if you don’t account for temporarily skewed profit margins.
Last in, first out
Under LIFO, you apply the cost of your most recent purchase orders to the cost of goods sold, while the cost of older inventory remains on the balance sheet as ending inventory. It is essentially a way to expense the purchase price of your most recent inventory, even if you use FIFO for fulfillment.
But why would you do that? With this method, you have to offset advantages now with future sales. The fact is, some companies can justify the complexity in their accounting records because the method can provide tax advantages when inventory costs rise. When your expense account increases, you can reduce taxable revenue. The tactic is best suited to companies with large inventories or volatile pricing.
How to implement FIFO and LIFO
The implementation of FIFO or LIFO approaches would be extremely challenging without real-time inventory management. But you can use either with a perpetual inventory system by assigning costs to each unit sold based on whichever cost flow assumption you choose. When your perpetual system updates your inventory records, it automatically updates your financial records, too.
Inventory valuation methods
You may also use certain valuation formulas for inventory management, regardless of your inventory system. These may not be necessary for your business but there are instances where they’re useful, like analyzing the big picture for a full asset account.
Weighted average cost
Weighted average cost (WAC) is an inventory valuation method that calculates the average cost of each individual item. It considers the total cost of goods available for sale and the total number of units available to create a standardized way of measuring performance and profitability.
To calculate WAC, you add the total value of the current inventory to the cost of producing that inventory to determine the cost of goods available for sale. Then, you divide this total cost by the total number of units in inventory, which includes the beginning inventory units and any additional purchases. This results in an average cost per unit that reflects the current cost of your inventory record.
There are a few limitations to this method that are worth noting. The first is that the formula standardizes inventory value across SKUs, but inventory isn’t standardized. Your store likely sells a wide variety of items with different wholesale prices, logistics requirements, and sale prices.
At scale, WAC loses effectiveness during times of economic volatility, too. Under those conditions, averaging out your accounting might hurt you because detailed inventory records let you find optimization opportunities right when you need them the most.
Another consideration is that your perpetual inventory system may not automatically provide WAC information. If this is an important formula for you, you might have to allocate manual resources to this type of valuation.
Economic order quantity
Economic order quantity (EOQ) is an inventory management model that determines the optimal quantity of items to order so that you can minimize the total costs of goods. The goal of EOQ is to find the balance between ordering too little, which increases unit costs, and ordering too much, which increases holding costs.
Calculating EOQ requires knowing annual demand values to calculate against ordering cost per order and holding cost per order. The formula is EOQ = √(2 × D × S) / H, where D is demand, S is ordering cost, and H is holding cost.
The problem with this model is that demand fluctuates. So do quantity discounts and lead times. You can use the formula to create a framework for optimal order quantities, but it may not be possible to configure your perpetual inventory system to get it exactly right. It’s more likely you’ll use the formula to validate your system’s recommendations, auditing orders against demand variability and your own negotiations with suppliers.
Pros and cons of perpetual inventory systems
A perpetual inventory system offers multiple benefits around efficiency, visibility, and accuracy. But it also presents potential downsides to consider. By understanding the different factors, you can select and configure your perpetual system in a way that works for you.
Perpetual inventory pros
The pros of a perpetual inventory system relate to real-time automation and visibility. The system does the recordkeeping for you, connecting inventory and financial data so you can focus on insights and strategy. Compared to the manual efforts of a periodic inventory system, a perpetual inventory method delivers speed and accuracy to meet ongoing ecommerce demands.
Inventory visibility
Real-time data means you always know what actual inventory you have in your warehouses, reducing the risk of stock shortages or overstocking. This visibility also lets you base your decisions on data. For example, getting notifications when stock levels run low can help you automate orders for easier replenishment and inventory that aligns with demand.
Forecasting and planning
A perpetual inventory system makes it easier to forecast performance and plan inventory accordingly. That’s because your inventory data offers valuable insights into sales trends, seasonal fluctuations, and other customer behavior. You can use these insights to determine order quantities, negotiate with suppliers, streamline fulfillment, and maximize pricing.
Customer satisfaction
Real-time inventory data can help you avoid risks to customer satisfaction. When your product availability is up to date across all sales channels, you can fulfill orders quickly, meet their demands for fast delivery, and increase the likelihood of customers coming back to your store.
Perpetual inventory cons
The considerations of a perpetual inventory system mostly relate to implementation and onboarding costs. Any change comes with challenges, but you can plan ahead to limit their impact.
Implementation costs
New perpetual inventory software requires upfront investments and ongoing costs. If you need extensive integrations or custom configurations, those may increase your investment.
Weigh the benefits of a perpetual inventory system against the costs and resources required for implementation. If your business is small, has a limited inventory, or experiences slow inventory turnover, a periodic inventory system may be sufficient. But if your business has complex inventory needs, high volume, or rapid turnover, it probably requires real-time stock accuracy that justifies the costs of implementation.
Change management
Change can sometimes involve a J-curve in performance, where certain performance indicators dip before they rise higher than before. Allocate enough time and resources to ensure a smooth implementation of your perpetual inventory system. Develop a transitional plan, set realistic timelines, and align with the right people at your company to help avoid unexpected issues.
Human error
A perpetual inventory system gets most of its data from your online store, fulfillment centers, and purchase orders. If the inputs are correct, the perpetual system provides you with accurate information, but initial data entry is typically made by error-prone humans.
If you enter the wrong order information or make a mistake on your store’s website or other channels, the data can create a cascade of errors that could ultimately impact forecasting. The same risk exists in warehouses. If someone grabs the wrong item during the picking item, it could create discrepancies in your system.
The bottom line on perpetual inventory systems
Perpetual inventory systems can streamline and improve inventory management by offering real-time tracking and recording of stock levels. These systems integrate with your sales channels and warehouse management systems, providing deeper, more meaningful visibility into inventory turnover and cost of goods. They also let you optimize operational efficiency and accuracy by automating tasks such as order replenishment.
These systems are vital for businesses to meet demand across multiple sales channels. Without them,you’d have to manually track physical inventory against transaction data on a periodic basis. That kind of manual effort leads to information gaps when it’s time to forecast, resulting in order quantities that miss the mark and stockouts that disappoint customers.
Some smaller businesses may do well without the automations of these systems, but for businesses with high SKU volumes, perpetual inventory systems make things easier and more accurate.
Work with Red Stag Fulfillment
Red Stag Fulfillment can help you make the most of the data in your perpetual inventory software by working to dial in your inventory management processes and demand planning. That way, you’re better able to place precise orders, maximize pricing, and keep cash flowing.
We also offer performance guarantees that hold us accountable for delivering great service for your business. On the rare occasion a mistake occurs, we’ll fix it (at no cost to you) and pay you a fee to cover the inconvenience.
Because, let’s be honest. If we make a mistake that hurts your business, it’s only right that it should hurt ours, too. With that level of accountability, you can trust that our motivations are always aligned with yours. No other fulfillment provider has guarantees that come even close to this.
Ready to get started? Reach out to start a conversation.
Frequently asked questions
What is a perpetual inventory system? It’s an inventory management method that uses real-time receiving and sales data to keep your stock quantities up to date. Most systems use your data to automate tasks that benefit your business, like using a perpetual system to automate replenishment orders at exactly the right time to avoid stockouts or overstock.
How does a perpetual inventory system work?
A perpetual inventory system works by following the order-to-cash cycle and updating inventory data at key points in the cycle. Those points are usually supply order placement, warehouse receiving, customer sales, and fulfillment. The perpetual system integrates with other tools like your point-of-sale and WMS to keep inventory data current across your supply chain.
What is the difference between perpetual inventory and periodic inventory?
With a perpetual inventory method, your inventory count is updated in real-time, relying on automated tools to track data and send notifications when you need to take action. A periodic inventory system is updated at specific intervals and typically involves a physical count to validate inventory levels against transactions. Some businesses may take a hybrid approach, automating most activity and doing periodic validations of physical inventory to reconcile any discrepancies that may occur over time.
Why do I need a perpetual inventory system?
Perpetual inventory systems are crucial for efficient inventory and accounting management, especially for businesses with multiple sales channels or complex inventory needs. Real-time data allows for better decision-making and greater inventory accuracy, helping you meet customer expectations.
What are the pros and cons of perpetual inventory systems?
Perpetual inventory systems offer benefits such as real-time automation, inventory visibility, accurate forecasting, and improved customer satisfaction. They streamline processes, provide valuable insights, and help businesses make informed decisions based on current data. Compared to a periodic system, perpetual inventory methods let you skip the need for physical inventories.
Considerations for perpetual inventory systems include implementation costs and change management challenges, but you can mitigate these with proper planning.
Can I outsource inventory management?
Outsourcing inventory management to a third-party provider (3PL) can be a smart decision for some ecommerce companies. A 3PL can let you focus on other parts of your business, like product-market fit and cash management.
Another key benefit of outsourcing inventory management is the flexibility it provides for storage space and handling. When you partner with a 3PL, you can easily scale up or down as needed without worrying about scaling up software or teams.
You may also find that while a perpetual inventory system helps you reduce inventory discrepancies through better management, a 3PL can mitigate those risks even further with a combination of expertise and performance guarantees.
Reach out to Red Stag to see how we can help.
