Okay, so we are told not to count our chickens before they hatch, but what about counting our eggs?
If you are counting your chickens, eggs and everything else in the henhouse, doing it again the following month, and again, the month after that, then you are engaged in the practice of periodic inventory.
A periodic inventory system assumes everything is for sale. Every unit of inventory is counted to provide the total stock numbers available for sale. This counting reoccurs over predetermined periods of time.
How it works
Periodic inventory works on a system that calculates the cost of the goods sold. This is done by taking the beginning inventory and adding net purchases to establish the cost of available stock. The end inventory is subtracted from this stock, to provide the total cost of goods sold.
There are four common costing methods in periodic inventory management:
- Specific Identification – used for certain items of inventory that are not generally interchangeable. Individual costs are determined and applied to particular items.
- First in, first out (FIFO) – assumes inventory leaves the business in the same order it was received. The inventory balance is assumed to be the most recently produced or acquired stock.
- Weighted Average – this method totals the cost of available goods for sale and divides it by the number of items for sale, resulting in an average cost per unit.
- Last in, first out (LIFO) – assumes the last piece of inventory purchased is the first to be sold. This costing method is not permitted in many countries around the globe.
Each of these costing methods will produce different results over the same period. Therefore, to maintain accuracy, one method is chosen and applied consistently across reporting periods.
The Uncounted Costs
Periodic inventory systems and costing methods do not guard against a fox in the henhouse. Fluctuations in inventory levels are not recorded as sales occur. Consequently, this method can conceal theft, spoilage or human error.
Occasionally the value of inventory will be lower than the recorded or purchase price. This occurs due to outdated / damaged stock or with the replacement of identical goods at a lower cost. When this occurs the inventory is recorded at the market or written down value.
All the Eggs, One Basket
Periodic inventory systems don’t necessarily present an accurate picture of stock movement. With the evolution of technology, they are becoming increasingly inefficient. Repetitive recurrent counting is an unproductive use of labour, and let’s face it, who looks forward to stocktake?
The use of barcodes and scanners make it easy to track inventory as in enters and leaves your business. Perpetual inventory tracks the cost of goods sold in real time, as the sale occurs. It provides more accurate costing, timely identification of restocking needs and detects any stock discrepancies.
And yes, you still need to do a manual count to confirm the paper record matches physical stock numbers. However, this is generally done only once, at the businesses end of financial year.
Which method would you prefer?