Inventory is the lifeblood of your business. You need enough inventory in stock to keep up with customer demand, but not too much that you are overpaying on storage costs. That’s where an inventory system comes into play.
The perpetual inventory system is a reliable way to keep track of inventory in real-time. Read on to learn what a perpetual inventory system is and how it works.
What is a perpetual inventory system?
A perpetual inventory system is a system used to track and record stock levels, in which every purchase and sale of stock is logged automatically and immediately. In this system, every time a transaction takes place, the software records a change in inventory levels in real-time.
What is perpetual inventory?
Perpetual inventory is an accounting method in which a business continuously tracks its inventory levels in real-time. This method makes more precise inventory counts available to a business at all times.
Perpetual inventory is distinguished from a perpetual inventory system, which usually refers to the software or program that executes the perpetual inventory accounting method.
What are the advantages of a perpetual inventory system?
A perpetual inventory system has a lot of advantages for ecommerce businesses of all sizes. Not only does it help track inventory data in real-time, but it also helps eliminate labour costs and human error. Let’s look at why ecommerce businesses choose to use a perpetual inventory system.
Records data in real-time
A perpetual system records inventory updates and movements as they happen. This means you can trust your inventory counts to be accurate at all times.
Provides a detailed paper trail
A perpetual inventory system tracks inventory movements and interactions throughout your ecommerce supply chain. This data will give you more insights about bottlenecks in your procedures, so you find ways to optimise your supply chain.
Decreases inventory management costs
With real-time updates, inventory holding costs and inventory replenishments are controlled and minimised. Since perpetual inventory systems automate many processes that would be manual, it can save on labour costs.
Calculates end-of-year inventory balance
Since a perpetual inventory system accounts for inventory continuously, your end-of-year inventory balance is calculated instantaneously when the year ends. This helps to make sure you have accurate inventory numbers to report on for accounting purposes.
Forecasts demand more accurately
A real-time inventory system makes forecasting demand simple. Historical inventory and sales data can be used to predict future sales cycles and ensure that you have an optimal amount of inventory during different times in the season, such as the holidays.
“ShipBob’s analytics tool is also really cool. It helps us a lot with planning inventory reorders, seeing when SKUs are going to run out, and we can even set up email notifications so that we’re alerted when a SKU has less than a certain quantity left. There is a lot of value in their technology.”
Oded Harth, CEO & Co-Founder of MDacne
How does the perpetual inventory system work?
A perpetual inventory system works by updating inventory counts continuously as goods are bought and sold. This inventory accounting method provides a more accurate and efficient way to account for inventory than a periodic inventory system. Here is a step-by-step overview of how this type of inventory system works.
Step 1: Point-of-sale system updates inventory levels
Whenever a product is sold, the inventory management system attached to the POS (point-of-sale) system immediately applies the debit to the main inventory across all sales channels. Barcodes or RFID (radio-frequency identification) scanners make this process quick and easy.
For example, let’s say you run a business that sells scented candles. A customer purchases 3 vanilla-scented candles (in other words, 3 units of a single SKU) for $10.00 per candle, or $30.00 total.
When a warehouse picker picks each unit, the picker scans each candle’s barcode. As soon as each barcode is scanned, your perpetual inventory system’s software decreases the overall inventory count for that SKU by 3.
With the perpetual inventory system, sales to customers also trigger two accounting journal entries on your income statement, and two on your balance sheet.
On your income statement, the amount of money the customer pays for the items — in this case, $30.00 — is recorded as a credit to revenue. On your balance sheet, this same amount is logged as a debit to accounts receivable or cash.
Step 2: Cost of goods sold is updated automatically
Whenever a product is sold or received, the cost of goods sold (COGS) gets recalculated.
Continuing the example above, we’ll assume that the COGS for each vanilla-scented candle (which factors in expenses like raw materials, warehouse labour, and overhead expenses) is $5.00 per unit. Every time a candle is scanned, $5.00 is added to your business’s overall COGS — meaning that after scanning 3 candles, the COGS increased by $15.00.
This $15.00 should be recorded in two more accounting journal entries. On your income statement, $15.00 is recorded as a debit to COGS. On your balance sheet, this same amount is credited to your inventory.
Step 3: Reorder points are adjusted frequently
Based on historical data, a perpetual inventory system will automatically update reorder points as sales increases or decreases to keep an optimal level of inventory at all times.
Following the previous example, let’s say your store offers a special holiday-themed candle, and for the past 4 years, sales for that candle have always risen in Q4.
A perpetual inventory system will learn from the sales data of the past 4 years, and automatically raise your reorder threshold from 25 units to 50 units. This way, you can reorder stock sooner than you normally would and prevent stockouts.
Step 4: Purchase orders are automatically generated
Whenever an item or SKU hits its reorder point, the system generates a new purchase order and sends it to your supplier with no human intervention.
For example, sales for your holiday-themed candle increase rapidly in Q4, just as you predicted. As soon as you have just 50 units of that candle left in stock, your perpetual inventory system will automatically generate a new purchase order for 500 more candles (to be bought at $3.00 apiece), and send it to your supplier.
This purchase transaction triggers another journal entry, this time only on your balance sheet. In this example, a total of $1,500 (500 units x $3.00 each) should be recorded as a debit to inventory, and a credit to either accounts payable or cash.
Step 5: Received products are scanned into inventory
When inventory is sent to your warehouse, a warehouse employee will scan product using a warehouse management software (WMS), so they appear in your inventory management dashboard and make them available for purchase on all or select sales channels.
In our example, let’s say the purchase order goes through, and after a week or two your supplier’s shipment of 500 candles arrives at your warehouse.
As your warehouse employees go through the receiving process, each unit is checked for quality and scanned with a barcode scanner before it’s moved to warehouse storage. As soon as a unit is scanned, the perpetual inventory system automatically increases the inventory count for that SKU by 1. Once all 500 units are scanned, the inventory count should have increased by 500.
What’s the difference between a perpetual inventory system and a periodic inventory system?
Periodic and perpetual inventory systems are two different inventory tracking methods that ecommerce businesses use to track and monitor stocked goods. The perpetual inventory system is more advanced and used more often than a periodic system.
A perpetual inventory control system tracks inventory in real time and centralises inventory data. Inventory data is available to all parts of the system to forecast sales trends, calculate reorder points, and source items that are currently out of stock.
A periodic inventory system is kept up to date by a physical count of goods on hand at specific intervals to calculate COGS using inventory valuation methods such as FIFI, LIFO, and weighted averages. With a periodic inventory system, a business calculates current inventory counts at the end of an accounting period or financial year and only then reports on it.
Perpetual inventory vs. Book inventory
Book inventory refers to the amount of stock a business has on hand, according to accounting records. It is not necessarily the same as actual inventory (which is the true amount of stock that a business has on hand), as inventory may be damaged, lost, stolen, or otherwise over- or under-counted in the books.
Perpetual inventory systems help keep your book inventory more accurate, as you’re less likely to miss transactions, damage, lost inventory, and other inconsistencies more quickly with detailed, real-time records.
Formulas used in perpetual inventory methods
In order to be more precise when ordering inventory items, formulas can be used. There are several formulas business owners can use to keep track of physical inventory counts. Here is a list of our favourites.
EOQ, or economic order quantity, is designed to find the optimal order quantity for businesses to minimise certain things like costs, warehousing space, and stockouts.
Formula: EOQ = square root of: [2SD] / H
S = Setup costs (per order, generally including shipping and handling)
D = Demand rate (quantity sold per year)
H = Holding costs (per year, per unit)
Finished goods inventory refers to the stock available to customers for purchase that can be fulfiled. With the finished goods inventory formula, sellers can calculate inventory cost.
Formula: (COGM – COGS) + Value of Previous Year’s Finished Goods
FIFO (first in, first out) is an inventory valuation method that sells the goods purchased first before goods purchased later. In theory, this means the oldest inventory gets shipped out to customers before newer inventory.
LIFO (last in, first out) is an inventory valuation method that uses the cost of the most recent products purchased to calculate the cost of goods sold (COGS), while older inventory value is considered ending inventory on a balance sheet.
Weighted average cost
Weighted average cost is an accounting system that uses a weighted average to determine the amount of money that goes into COGS and inventory.
Formula: Cost of goods available for sale / Total number of units in inventory
How to optimise your inventory management processes
Choosing a perpetual inventory system over one that is manual and time-consuming is the first step in managing inventory. But you also need the right technology and partners to optimise your inventory tracking systems and processes.
Order fulfilment can’t be done properly without the right inventory management process in place. Third-party logistics (3PLs) allow merchants to outsource fulfilment, including warehousing, inventory management, pick and pack, and shipping. With ShipBob, you can spend less time on inventory management tasks, while still having full visibility into the fulfilment process.
Skubana partners with ShipBob and offers advanced perpetual multi-channel inventory management features, such as automatic stocking, inventory reporting, and powerful analytics.
“The fulfilment network we switched to appeared to have a solution to this by automatically calculating that figure and syncing directly with the product page.
However, we learned that the inventory figures can’t be trusted. For example, our store view would show negative units of a product in stock, but the fulfilment inventory counts would show thousands of units available.
With ShipBob, we were able to mark any combination of SKUs as a unique bundle and select the component SKUs right through the dashboard.
Each time that bundle was fulfiled by ShipBob, we could see the individual components that were physically picked, and we would know that the order went out as expected. ShipBob also allowed us to make changes to bundles on the fly with complete control and visibility.”
Gerard Ecker, Founder & CEO of Ocean & Co.
A perpetual inventory system is the best choice for fast-growing ecommerce businesses. A periodic inventory system has a high probability of discrepancy and weaker stock control. With a perpetual inventory system, you’re able to centralise inventory management, optimise stock levels, and much more.
ShipBob’s fulfilment technology comes with built-in inventory management tools, including demand forecasting, order management, and data and analytics. To learn more on how ShipBob can support your ecommerce business, click the button below to request information.
Have your own warehouse?
ShipBob has a best-in-class warehouse management system (WMS) for brands that have their own warehouse and need help managing inventory in real time, reducing picking, packing, and shipping errors, and scaling with ease.
With Merchant Plus, brands can even leverage ShipBob’s fulfilment services in any of ShipBob’s fulfilment centres across the US, Canada, Europe, and Australia to improve cross-border shipping, reduce costs, and speed up deliveries.
Perpetual Inventory System FAQs
Inventory tracking is an important part of your ecommerce business. It is key to having stock available for sale and ensures you keep COGS to a minimum. A perpetual inventory system is the most common method used by fast-growing ecommerce businesses.
1. What is a perpetual inventory system?
A perpetual inventory system is an inventory method that tracks changes in stock levels in real-time. It provides a detailed overview of inventory on hand and goods sold.
2. How does a perpetual inventory system work?
With the use of inventory management software, a perpetual inventory system tracks inventory levels and orders in real-time and centralises the data in one place.
3. Why do companies use perpetual inventory systems?
A perpetual inventory system gives an ecommerce business an accurate view of stock levels at any time without the manual process required for a periodic inventory system. The automation that a perpetual inventory system provides frees up time and capital.
4. What is the advantage of a perpetual inventory system?
A perpetual inventory system is more accurate than the less advanced periodic inventory system. Having a more accurate count of inventory at all times prevents stockouts and overstock issues.