Understanding the periodic inventory system for small to medium businesses

When every dollar and cent counts in the search for profitability, deploying an effective inventory management system can be a huge benefit.

Managing over- or under-stocking can reportedly reduce inventory costs by 10%, but 43% of businesses in the US do not actively monitor stock levels.¹

A periodic inventory system can be a valuable way to address this issue. In this article, we will explore the benefits and challenges, as well as strategies for implementation.

What is a periodic inventory system?

A periodic inventory system calculates stock levels and the cost of goods sold (COGS) at set intervals, say monthly. This is in contrast to a perpetual stock counting system where the balance is continually updated – a process that can be time-consuming and burdensome, especially for businesses that sell lower volumes. The periodic inventory system allows organizations to compare inventory sales at the beginning and end of a fixed period, using the results to make appropriate stocking and accounting decisions.

How does periodic inventory work?

• Set counting intervals: A business can define its own inventory tracking intervals. This is often monthly, quarterly, or annually, and will depend on the sales volume, product types, and sector.
• Inventory count: Employees will physically count the stock items at the end of the set period, including all inventory, including products in transit or currently unavailable.
• Record the count: Product quantities are recorded on a digital database, which is stored on inventory management software. They can then be used in calculations to track inventory flows and trends.
• Calculate the Cost of Goods Sold (COGS): COGS is the amount it costs in a given period of time to manufacture and sell your products. A basic formula looks like this: (Cost of starting inventory + Cost of acquiring new inventory) – Ending inventory = Cost of Goods Sold.

Learn more about COGS and why this calculation is important.

When is a periodic inventory system used?

• Intermittent tracking needs: Periodic inventory systems are used in situations where a perpetual system is not appropriate. This may be due to stock levels being low in volume and/or slow-moving.
• Limited resources: A manual approach may be more practical if a small business does not have the resources to use automated perpetual count technology, which can be costly and difficult to maintenance.

The benefits of a periodic inventory system

• Simplicity and affordability: By counting manually and periodically, a perpetual counting system is not required. This may reduce technical complexities and associated costs.
• Resource efficiency: Counting stock only when necessary, can help reduce staff workloads and free up resources for other business activities.

The challenges of periodic inventory

• Lack of real-time insights: Information gaps can occur between counting periods, meaning the system may not be as responsive to changes in demand. Businesses with shifting sales levels may need to increase the frequency of their counting periods.
• Inventory discrepancies: An inventory count is only as accurate as the staff conducting it. Discrepancies can occur through human error, creating future accounting issues.
• Inventory carrying costs: Storing unsold goods can be costly. A periodic count may not reveal depreciation and lost opportunities quickly enough.

Tips for implementing a periodic inventory system

• Set counting intervals: Select a counting period that reflects the speed of sales, seasonal fluctuations, and accounting needs. The length of intervals should remain under review to ensure the system is providing the right data for business decisions should trading conditions change.
• Track and document with accuracy: Reliable counting and record-keeping is fundamental to an effective periodic inventory system. This ensures monthly, quarterly, and annual records are reliable and can be used to make meaningful business decisions.
• Collaborate with vendors: Collaboration can align orders and reduce overstocking. This reduces inventory carrying costs and overstocking.

Strategies for making the most of periodic inventory

• Forecast demand: Historical data can help businesses predict inventory needs between counting periods. This reduces the risk of over- and under-stocking.
• Calculate safety stock levels: Periodic counting determines safety stock levels and reduces stockouts during periods of higher demand.
• Conduct regular audits: Identify discrepancies and continually adjust inventory systems for increased profitability. Keep the system under regular review to ensure it's working for your business.

Explore insights that can help you grow, drive sales, and optimize your operations management strategy. Visit the PayPal Resource Center for detailed guides designed for small medium businesses.