No matter what you’re selling in your store, you need a rough idea of your inventory's worth. This figure helps determine your business's profitability, your balance sheet, and whether you’ve got too much money tied up in stock.
The problem is that valuations fluctuate almost daily. As soon as a product is sold or you get a new shipment, your inventory is worth a different amount. How do you keep up?
Periodic inventory is an inventory accounting method that some retailers use to value their inventory on a specific schedule. Instead of having an ongoing figure that fluctuates day-to-day, retailers using the system value their stock at certain times, such as every week, month, or quarter.
If you want to use the periodic inventory system or are simply wondering whether it’s the better option for your retail store, you’re in the right place. We’ll share the pros and cons of this model alongside the steps you can take to do a physical inventory count with the periodic system.
Table of contents
What is a periodic inventory system?
A periodic inventory system allows retailers to count and value their inventory. Unlike other inventory management and accounting methods, stock levels are not continuously monitored or updated with the periodic system. Inventory is counted and valued at specific intervals, such as weekly, monthly, quarterly, or at the end of a business's tax year.
The periodic inventory system also helps you calculate the cost of goods sold (COGS) in a specific reporting period. This shows how much money you’ve spent on products you’ve already sold, including cash you’ve spent on product development, materials, labor, and operations.
You’ll see it on important financial documents like tax returns, balance sheets, and income statements because it’s a good way to measure how profitable your business is.
Periodic vs. perpetual inventory
Periodic and perpetual inventory systems are two different methods that businesses use to value and track their inventory. The biggest difference between the two is the timing in which the physical inventory count takes place. Periodic inventory counts happen after a specific accounting period (e.g., every week), whereas perpetual inventory counting values stock in real-time.
How the periodic inventory system works
Choose an inventory valuation method
If you were to look at the shelves of inventory sitting in your stockroom, how would you value it? A gut feeling is the wrong answer. Instead, use an inventory valuation method to make sure you’re not making biased valuations and are basing figures on facts:
- First in, first out (FIFO). This model assumes that your oldest units will be sold first. It’s “ypically the most common method, since it’s easy to use and provides the most accurate picture of costs and profitability.
- Last in, first out (LIFO). This model assumes that your newest products are sold first. This method can lower your tax liability because you’ll make less profit, but it requires you to keep more complex accounting records.
- Weighted average cost (WAC). This model is the middle ground between FIFO and LIFO. It values inventory by dividing the cost of goods purchased by the number of units available, which is best suited to retailers that sell various products at different prices.
Each inventory valuation has its pros and cons. Regardless of which you choose, it’s important to stick with it. If you’re using the periodic FIFO inventory system for beginning inventory and WAC for closing, you’ll end up with two completely different figures that don’t match. Sticking to the same model helps you compare apples to apples and paint a more accurate picture of how much your inventory is worth.
Value beginning inventory
To value your inventory and track how this changes over time, calculate how much your inventory is worth at the beginning of the reporting period. If you’re using the periodic review inventory system to value stock monthly, you’d run through all of the products in your stock room and jot down the dollar value of your beginning inventory on the 1st of the month.
Value recently purchased inventory
Next, look over the accounting period and note how much you spent on new products. If you brought in 1,000 new units and it cost you $5,000, for example, this would be your purchase figure in the periodic inventory formula.
Value ending inventory
Ending inventory, sometimes known as closing inventory, calculates how much inventory you’re left with at the end of the reporting period. For monthly reporting, you’d go through your stock room and do a physical count to determine the value of your remaining inventory on the last day of the month.
Apply the COGS formula
The periodic inventory formula is the same as the cost of goods sold formula: (beginning inventory + purchases) — ending inventory. With this formula, you can track the value of your inventory over a longer period of time and calculate the COGS to show on your business’s balance sheet.
Periodic inventory example
Let's say a retailer conducts a monthly inventory count using the periodic system. At the beginning of the month, the store had an inventory worth $40,000. Throughout the month, the business owner purchases $5,000 in new products and sells $3,500 units to customers. At the end of the month, they conduct another periodic inventory count and find that their ending inventory is worth $40,000.
To determine the COGS for the month, they subtract the ending inventory ($40,000) from the initial inventory plus purchases ($40,000 + $5,000). This would mean their COGS is $5,000.
Advantages of a periodic inventory system
It's easy to maintain
Periodic systems only require you to count inventory at a set time, which means it's generally easier and less resource-intensive to count stock. You don't need expensive software or to spend time getting to grips with real-time counting.
It's flexible
You choose how often you value your inventory, be that once a week, month, quarter, or year. Scale this up or down depending on how quickly your inventory moves. The timeframe can ebb and flow throughout slow and busy periods of the year.
It’s ideal for small retail stores
Because periodic inventory is a simpler and less complex accounting method than the perpetual system, it’s ideal for retailers who have a small number of SKUs. It’s also suitable for stores with slow-moving inventory. If goods tend to stick around for a longer period of time, investing in real-time tracking might not be the best use of your time.
Disadvantages of a periodic inventory system
Manual inventory counts are time-consuming
Manual inventory counts can be time-consuming and labor-intensive. You'll need someone to go through and do your stock checks, but you're busy managing the store, and retail staff are busy serving customers. This system might force you to close the store or work outside your opening hours to cycle count.
It's prone to human error
As much as we try, it's impossible for everyone to get everything right all of the time. The same applies to periodic inventory counts. You might double count one item, forget about a specific SKU, or miscount how many items you're looking at. All of these issues can wreak havoc with inventory valuations.
Forecasting becomes difficult
Poor demand planning costs retailers a collective $350 billion per year in lost revenue. Why? Because if a product isn’t available in a store, some consumers will buy it from a competitor.
Since inventory levels are not continuously monitored with the periodic system, you won’t have complete visibility over your stock at all times. This results in a higher risk of stockouts occurring between inventory counts.
Is the periodic inventory system right for your store?
The periodic inventory isn’t the best choice for all retailers, but it does have its advantages. Some business owners like the routine and direct involvement in inventory counting, whereas others lean toward the perpetual inventory system for a more hands-off and real-time approach.
The truth is that while perpetual is generally more effective, no system is better than the other. It’s a matter of trial and error to see what works for your retail business. You can always pivot from one to the other if you find it’s not working.
