There are many inventory valuation methods available for businesses to use, and picking the right valuation method can have long-lasting effects. One of the more common and simplistic valuation methods is a periodic inventory system.
Periodic inventory systems are commonly used by startups and small businesses, and you might be wondering if it’s the right method for you. In this article, we’ll take a look at what periodic inventory is, how to implement it, and how it can benefit your business.
What is periodic inventory?
Periodic inventory is a system of inventory valuation where the business’s inventory and cost of goods sold (COGS) are not updated in the accounting records after each sale and/or inventory purchase. Instead, the income statement is updated after a designated accounting period has passed.
How does periodic inventory work?
In a periodic system, businesses don’t keep a continuous record of each sale or purchase; inventory balance updates are only recorded in a purchases account over a specified period of time (e.g., each month, quarter, or year).
At the end of the accounting period, the final inventory balance and COGS is determined through a physical inventory count.
What is the difference between the periodic inventory and perpetual inventory systems?
A periodic inventory system measures the level of inventory and cost of goods sold through occasional physical counts. In contrast, the perpetual inventory system is a method that continuously monitors a business’s inventory balance by automatically updating inventory records after each sale or purchase.
The periodic inventory system is ideal for smaller inventories and order volumes, whereas fast-growing or midsize to large businesses usually resort to a perpetual system for more accurate and real-time records.
How do you calculate periodic inventory?
It’s straightforward to calculate the cost of goods sold using the periodic inventory system. First, we’ll walk through the elements needed and then an example.
Cost of Goods Sold (COGS) = (Beginning Inventory + Cost of Inventory Purchases) – Closing Inventory
Periodic inventory formula
As periodic inventory is an accounting method rather than a calculation itself, there is no formula. However, we will use the formulas for calculating cost of goods sold and cost of goods available.
To calculate the cost of goods available, add the account total for purchases to the inventory’s initial balance.
Cost of Goods Sold (COGS) = Cost of Goods Available – Closing Inventory
Then, at the end of an accounting period, take a physical count of each item. This will be your ending inventory balance.
Finally, subtract the ending inventory balance (or closing inventory) from the cost of goods available to determine the COGS.
Cost of Goods Available = Beginning Inventory + Purchases
A periodic inventory example
Now we’ll take a look at how you’d practically apply periodic inventory to your business. Let’s say you run an ecommerce store and:
- You start off with inventory worth $200,000.
- Your business spends $250,000 on inventory purchases over the accounting period.
- When you conduct a physical inventory count at the end of the period, your closing inventory is worth $100,000.
As mentioned, we need to calculate the cost of goods sold using this formula:
Cost of goods sold (COGS) = Beginning inventory + Purchases – Closing inventory
Plugging the values in, we get:
COGS = $200,000 + $250,000 – $100,000
COGS = $350,000
Using the periodic inventory method, the total cost of goods sold for the period comes to $350,000.
What are the advantages of using a periodic inventory system?
Periodic inventory allows a business to track its beginning inventory and ending inventory within an accounting period for their financial statements. Here are some of the ways it can benefit your business.
1. Easy to implement
Periodic inventory systems are relatively simple to implement as it requires fewer records than other valuation methods. The calculations are easy too.
2. Great option for small business
A periodic inventory system is best suited for smaller businesses that don’t keep too much stock in their inventory. For such businesses, it’s easy to perform a physical inventory count. It’s also far simpler to estimate the cost of goods sold over designated periods of time.
3. Requires minimal information
While a perpetual system requires comprehensive information about each sale and purchase, periodic systems don’t need to monitor each transaction. Periodic inventory systems are very simple in the world of ecommerce bookkeeping and can compute the cost of goods sold and available for small inventories using a few data points.
What are the drawbacks of using a periodic inventory system?
The periodic inventory system can be risky for many businesses as stock levels are not up to date, leading to delays in issues being identified, inventory write-offs, and major challenges with inventory forecasting as you don’t always have exact figures on finished goods inventory, or the total stock available for customers to purchase.
Periodic inventory can also be more prone to human error as it relies on physical inventory audits rather than a more automated system that’s tracked digitally. By the time a physical count is completed, there may be inventory reconciliations needed to address stock discrepancies. Recordkeeping in a periodic inventory system may also become more time-consuming as your business grows and you add more inventory items. You might want to consider ecommerce accounting software and automated methods, such as the perpetual inventory system, if your business is growing fast.
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ShipBob makes it easy to track inventory days on hand and other metrics like:
- Historical stock levels at any point in time in any location
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- And much more
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Periodic inventory FAQs
Here are some common questions that business owners have about periodic inventory systems with answers to give you some guidance.
What is a periodic inventory system?
A periodic inventory system is a method of inventory valuation where the account is periodically updated. In other words, the factor that determines changes to recorded inventory balance is not triggered by each new order but rather an overall time period.
How are periodic and perpetual inventory systems different?
A periodic inventory system measures the inventory levels periodically through physical counts. The perpetual method continuously updates inventory records after each sale or purchase, monitoring the inventory balance. Small business owners with less inventory benefit more from periodic systems than larger merchants.
How to do periodic inventory systems
To implement a periodic inventory accounting system, all you need is a team to perform the physical inventory count and an accounting method for determining the cost of closing inventory. The LIFO (last-in first-out), FIFO (first-in first-out), and the inventory weighted average methods are all promising calculation techniques.
How to record periodic inventory systems
For the periodic inventory method, there’s no need to continually record the inventory levels. Only the beginning and ending balances are needed, often completed by a physical count to calculate inventory value. Because updates are so infrequent in a periodic inventory system, no effort is made to keep real-time records of customer sales, inventory purchases, and the cost of goods sold.