Periodic Inventory: How It Works, When to Use It & How to Implement It

Periodic inventory is a method of tracking inventories and updating the records at the end of the accounting period. This method is simple and more cost-effective. Here, the worker physically counts the goods left in the warehouse at the end of the accounting period to calculate the cost of goods sold. Small businesses usually use the periodic inventory method as they cannot afford advanced software which can update remaining or sold inventories in real time.

COGS =Opening Inventory + Purchases - Ending inventory

How The Periodic Inventory Process Works In Real Business Environments?

1. Schedule Counts

Businesses usually schedule their periodic inventory, i.e., weekly, monthly or annually, depending on stock value. For example, businesses usually prefer the periodic inventory method on a monthly basis to improve accuracy. Small enterprises do periodic inventory on an annual basis for financial reporting. Medium-sized businesses prefer quartering the physical counting of inventories to reduce cost.

More frequent counting of inventories in a business improves accuracy but increases labour costs. Simultaneously, less frequent counts can reduce immediate costs but can increase errors.

2. Preparing For The Count

Preparing for the physical counting of inventories stored in the warehouse requires careful planning. Businesses usually announce the sale in advance so staff can prepare for the periodic inventory. Some 3PL warehouses halt dispatch processes or restrict stock movement during the counting period to improve accuracy. The staff is assigned to separate zones in the warehouse for physical counting. Proper planning before a periodic inventory can ensure the process runs smoothly, accurately, and reliably.

3. Performing The Count

The warehouse supervisor assigns each team a separate zone for physical inventory counting. One person counts the inventory while the other records it on paper or a device. The staff usually counts the highly valuable items twice to reduce errors. The staff also identifies the damaged products during this process and keeps them separately. The supervisor does the periodic inventory of a particular product randomly to validate results.

4. Updating The Books After The Count

The staff then compares the physical counting with the recorded purchase and opening inventory. The book stock and actual stock can vary. The staff investigates it properly and corrects the discrepancies. The staff finally calculates the cost of goods sold based on the closing inventory.

Common Business Situations Where Periodic Inventory Makes Sense

1. Small Local Retail Stores

Small grocery shops, local retail stores or hardware stores usually use the periodic inventory method. They have small stock volumes, so they can easily perform physical product counts monthly or quarterly and track their stock levels.

2. Seasonal Businesses

Businesses that sell seasonal products, such as fireworks, can conduct periodic inventory checks before and after the peak season.

3. Start-up business

New businesses can use the periodic inventory method to reduce operational complexity. It can move to more advanced ones as sales volume increases.

When Periodic Inventory Does not Work?

Inventory Shrinkage Goes Unnoticed Between Counts 

A warehouse staff member notices inventory shrinkage only when physically inventory counting. So if theft, recording errors, or damaged inventory are present, they don't go unnoticed until the next counting cycle. Late identification can lead to financial losses for the business.

Poor Forecasting

In the periodic inventory system, stock levels are not updated in real time. This can lead to poor forecasting and cause overstocking or understocking. Overstocking increases the business's storage costs, while understocking decreases customer satisfaction.

Not Suited For High Velocity Environments

E-commerce websites and FMCG distributors usually have high order volumes. The stock levels change consistently in the warehouse. Periodic inventory systems do not provide real-time updates regarding inventories, and hence, a business can make replenishment decisions effectively. Delayed visibility can cause overstocking, understocking and late product delivery to the customer.

Inventory Value Distribution

In periodic inventory, the staff updates the inventory at the end of the accounting period. So, financial statements do not reflect the true inventory value every month or quarter. The business even calculates the cost of goods sold after physical counting, which can lead to incorrect profit value. This can adversely affect the cash flow planning of the business.

Periodic VS Perpetual Inventory: A Decision Framework, Not A Feature Battle

Decision Factor	Periodic Inventory	Perpetual Inventory
Main role	The staff updates the inventory after physical counting.	Inventory gets updates in real time, after every sale, purchase or return.
Cost	Low set up cost	Requires a high setup cost. The business needs to use WMS, ERP or barcode scanning.
Labor effort	Heavy effort especially during physical counting.	Less effort.
Inventory visibility	No real time visibility of products stored inside the warehouse.	Real-time visibility of products in a perpetual inventory model. It avoids the problem of overstocking and understocking issues.
SKU complexity	It work best with limited SKUS.	It works best for high SKU counts.
Industries	It works best for startups or small retailers.	It works best for ecommerce,electronics and pharmaceutical business.

Implementation Tips: How To Do Periodic Inventory Right

1. Pre-count Planning

Precount planning plays an important role in the periodic inventory system.

Businesses need to announce the date in advance so that teams can prepare properly. The staff need to clean and organise the stored products in the warehouse. They need to identify the damaged products and keep them aside. The workers even need to stop the stock movement during the physical counting of products.

The warehouse provider can assign a team to specific zones and provide them with clear instructions while counting products.

2. Sequencing By Value Or Velocity

The business needs to decide the order in which products are counted based on their value or risk. For example, businesses need to prioritise highly valuable information, as small errors can cause financial losses. Simultaneously, it needs to count fast-moving products first, as there are more possibilities of discrepancies because of frequent handling.

The staff needs to count slow-moving products later, as they do not have much impact on financial value.

3. Staff Training

The business needs to provide staff training before physical counting. The warehouse staff needs to know how to count inventories properly to avoid errors. For example, they can follow the two-person method in which one person coins and the other person records data in an Excel sheet or a system. The staff should even know how to handle expired or damaged products properly.

Proper training can reduce errors in the periodic inventory method.

4. Reconciliation Best Practices

Here, reconciliation means the physical counting of products should match the accounting records. The warehouse staff needs to count the products and compare them with the opening inventory and purchases. If the staff find any discrepancies, they should determine the exact reasons or recount the product, then make adjustments to the accounting records.

Final Words

Periodic inventory involves physically counting inventories at the end of the accounting period to determine their value stored in the warehouse. This method is quite simple and cheap. It relies completely on manual processes. However, periodic inventory does provide accurate results. It lacks real-time visibility into products, which can lead to overstocking and understocking. Businesses can accurately forecast near-term product demand.