# Perpetual Inventory System Explained: Benefits, Drawbacks & Use Cases

> **Definition**
>
> A perpetual inventory system is a computerized method that continuously tracks inventory levels in real-time, allowing businesses to maintain accurate records without physical inventory checks.

## What Is a Perpetual Inventory System?

A perpetual inventory system is a computerized system that continuously records inventory changes in real-time. This reduces or, in some cases, eliminates the need for physical inventory checks. Relying on data provided by electronic point-of-sale technology, it provides a highly detailed view of changes in [inventory](https://www.investopedia.com/terms/i/inventory.asp) and immediate reporting on the amount of inventory in stock.

Perpetual inventory systems are suitable for large companies with complex inventories and high sales volumes. Perpetual inventory systems differ from [periodic inventory systems](https://www.investopedia.com/terms/p/periodicinventory.asp), in which a company must instead depend on regularly scheduled physical counts. However, there is the occasional need for physical counts to verify inventory accuracy.

When integrated with accounting and finance, perpetual inventory systems lead to better regulatory adherence and customer service.

### Key Takeaways

*   Perpetual inventory systems offer real-time tracking and constant updates on inventory levels, providing businesses with an ongoing assessment of stock that aids in efficient inventory management and forecasting.
*   While beneficial for large companies with complex inventories and multiple locations, perpetual inventory systems can have high startup costs, making them less feasible for small businesses with limited resources.
*   Despite the automation and continuous updates, perpetual inventory systems still require periodic physical counts to reconcile discrepancies from loss, theft, or damage, which the system itself cannot account for.
*   Perpetual inventory systems can integrate seamlessly with financial and accounting systems, allowing for accurate preparation of financial reports and improving overall business operations.
*   The integration of real-time data in perpetual inventory systems facilitates smart decision-making, quicker response to changing market demands, and provides a detailed audit trail for better business insights.  
      
      
    

![Perpetual Inventory](https://www.investopedia.com/thmb/WBRiidXQB7lowtrhA-8KwLNuSCU=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Perpetual-Inventory-Final-resized-c761f5555df546f497fee5148e388346.jpg)

*— Matthew Collins / Investopedia*

## How Perpetual Inventory Systems Work

Perpetual inventory systems may be preferable to older periodic inventory systems because they allow for immediate tracking of sales and inventory levels for individual items, which helps to prevent running out of stock.

A perpetual inventory does not need to be adjusted manually by the company's accountants, except to the extent that it deviates from the physical inventory count due to loss, breakage, or theft.

[System software](https://www.investopedia.com/best-inventory-management-software-5088863) provides real-time updates to inventory through the use of barcode scanners or other computerized records of product acquisition, sales, and returns as they occur. This information is fed into a continually adjusted perpetual database.

The system allows for integration with other areas, including finance and accounting teams. This helps ensure adherence to tax and other regulations. Employees can use perpetual inventory data to provide more accurate customer service regarding the availability of products, replacement parts, and other physical components.

> **Important**
>
> Because perpetual inventory systems lack the ability to account for loss, breakage, or theft, a periodic (physical) inventory can still be necessary.

## Comparing Perpetual and Periodic Inventory Systems

The differences between [perpetual and periodic inventory systems](https://www.investopedia.com/articles/investing/053115/understanding-periodic-vs-perpetual-inventory.asp) go beyond how the two systems function, although that is the main point of distinction.

Perpetual inventory systems track sales constantly and immediately with computerized point-of-sale technology. Periodic inventory systems only track sales when a physical count is ordered and require a point-in-time count.

Large companies or those with complex inventories are well-suited to a perpetual system. Smaller companies with limited inventory can often survive with a periodic system. The same applies to the margin for error, which is lower with a perpetual system, although a limited, uncomplicated inventory may not suffer much with a periodic system.

The [cost of goods sold (COGS)](https://www.investopedia.com/terms/c/cogs.asp) is an important accounting metric derived by adding the beginning balance of inventory to the cost of inventory purchases and subtracting the cost of the ending inventory. With a perpetual inventory system, COGS is updated constantly instead of periodically with the alternative physical inventory.

Once set up, a perpetual inventory system requires less effort than a physical one. However, the startup costs for a perpetual inventory system are greater.

## Pros and Cons of Using Perpetual Inventory Systems

Proponents of perpetual inventory systems don't always go out of their way to point out the downsides of these systems, the chief of which is the lack of accounting for loss, breakage, or theft.

On the other hand, detractors don't necessarily note that reported stockouts without corresponding sales can signal theft or loss and trigger a physical inventory check faster than with a periodic system.

When deciding how to maintain control over physical inventory, it's prudent to carefully weigh both the pros and cons of any system under consideration.

### Pros

*   **Real-time updates.** A perpetual system, as the name implies, provides ongoing updates regarding purchases and sales. Managers and employees alike can monitor these data and use them as needed in real-time.
*   **More informed forecasting.** The ability to track customer buying patterns and seasonal fluctuations, and the opportunities that this information provides, are important advantages of a perpetual inventory system. Knowing and updating customer buying patterns allows for a stocking plan that minimizes either excess or inadequate stock, which can result in losses.
*   **Multiple-location management.** Monitoring inventory at multiple locations is a major challenge in inventory management. A connected perpetual inventory system creates a number of fulfillment opportunities, including moving stock from one location to another and managing inventory levels for all locations internally.
*   **Preparation of financial statements.** This system simplifies financial report preparation. One of the components of financial statements is inventory value; having the amount and value of the available stock recorded directly in the system can speed up the preparation of financial reports and avoid the errors of manual calculations.
*   **Reduction of downtime or store closures.** Relying only on periodic physical inventories leads to tough decisions for businesses. Do they tie up employees' time, even close stores on a frequent basis, to conduct inventories and gain accuracy, or do they opt for less frequent stock counts and sacrifice up-to-date data? A perpetual inventory system eliminates those problems.

### Cons

*   **Loss of stock.** This can occur due to damage, spoilage, and theft, among other reasons. When the estimated perpetual inventory does not match up to a subsequent physical inventory, that discrepancy equates to a loss.
*   **Improper inventory tracking.** Scanning errors, misplacement of products, software malfunction, or operator (employee) errors can degrade the efficiency of a perpetual inventory system. When this happens, tracking the company's goods and inventory in the warehouse or store will hamper business operations.
*   **Hacking.** Computer systems, despite their speed and efficiency, are susceptible to malfeasance in the form of hacking. Hacking threatens the security and accuracy of all data and information and forces the implementation of cybersecurity measures that can be expensive.
*   **Cost.** Perpetual inventory systems are expensive, especially on the front end, due to the cost of equipment, software, and training. Updates to all of the above are part of the ongoing cost of maintaining a perpetual system. For a small company with limited inventory and small margins, a perpetual system may not be affordable or even necessary. (However, larger companies or those with multiple locations may see cost savings.)
*   **Need for physical inventory.** Due to the eventual need to “count stuff,” a physical inventory, at least on an annual basis, is prudent if not absolutely necessary. Although physical inventories can't be eliminated, their number can be reduced under optimal circumstances.

## Ideal Situations for Implementing a Perpetual Inventory System

Large companies with a high volume of constantly rotating physical inventory should consider implementing a perpetual inventory system. The same applies to businesses with multiple locations. Companies expecting future growth might also consider implementing a perpetual inventory system.  

Other factors that can affect the need for a perpetual inventory system include:

*   The size of the company's margins and its ability to afford implementation and ongoing operating costs
*   The size of the inventory to be managed
*   The ability of vendors to respond to different types of inventory management methods  
    

## Implementing a Perpetual Inventory System: A Guide

To calculate inventory, companies need to set up a system where every piece of inventory is entered into the system and deducted from the system as it's sold. This requires the use of [point-of-sale terminals](https://www.investopedia.com/terms/p/point-of-sale-terminal.asp), barcode scanners, and perpetual inventory software to update estimated inventory with every product purchase and sale.

Since a perpetual inventory system estimates stock on hand, it does not replace a periodic physical inventory. At some point, a physical inventory should take place.

Businesses that use a perpetual inventory system typically employ cycle counting or the process of physically counting a portion of inventory to use as a baseline to check the accuracy of the perpetual system. The intent is to complete a full physical inventory over time.

### Inventory Management

[Inventory management](https://www.investopedia.com/terms/i/inventory-management.asp) refers to the processes involved in ordering raw materials, storing and using them to create products, and ultimately selling products to an end user. There are four main inventory management methods:

*   [Just-in-time (JIT) management](https://www.investopedia.com/terms/j/jit.asp)
*   [Material requirements planning (MRP)](https://www.investopedia.com/terms/m/mrp.asp)
*   [Economic order quantity (EOQ)](https://www.investopedia.com/terms/e/economicorderquantity.asp)
*   [Days sales of inventory (DSI)](https://www.investopedia.com/terms/d/days-sales-inventory-dsi.asp)

Each of these methods has its pros and cons when it comes to use within a perpetual inventory system.

The use of a perpetual inventory system makes it particularly easy for a company to use the economic order quantity (EOQ) method to purchase inventory. EOQ is a formula that managers use to decide when to purchase inventory based on the cost to hold inventory as well as the firm's cost of ordering inventory.

### Cost of Goods Sold (COGS)

When a company sells products in a perpetual inventory system, the expense account increases and grows the cost of goods sold (COGS). COGS represents production costs and expenses during a specific period. This includes the materials and labor costs, but not distribution or sales expenses. The formula for COGS appears below.

COGS = BI + P - EI

BI = Beginning inventory

P = Purchases for the period

EI = Ending inventory

A perpetual inventory system maintains a continuous tally of transactions, making the COGS available at any time. By contrast, a periodic inventory system calculates the COGS only after conducting a physical inventory.

The advantage of a perpetual system in providing a rolling estimate of COGS is clear. A company knows, after each transaction, how much it costs to produce products sold at that point. By updating these data on a continuous basis and integrating them with other business systems, the company has actionable information available on a 24/7 basis as a way to respond to increased costs in a timely manner.  

### Calculating Gross Profit

Gross profit is the result of subtracting COGS from revenue. Recall that COGS includes the cost of labor and materials but not sales or distribution costs. The formula for gross profit is:

Gross Profit = Revenue - COGS

The ability to estimate COGS continuously also provides a company using a perpetual inventory system the ability to estimate gross profit continuously. That’s because every transaction is recorded in real-time under a perpetual inventory system.

## Examples of Costing Systems for Inventory Management

Companies can choose among several methods to account for the cost of inventory held for sale, but the total inventory cost expensed is the same using any method. The difference between the methods is the timing of when the inventory cost is recognized, and the cost of inventory sold is posted to the cost of sales expense account.

The [first in, first out (FIFO)](https://www.investopedia.com/terms/f/fifo.asp) method assumes that the oldest units are sold first, while the [last in, first out (LIFO)](https://www.investopedia.com/terms/l/lifo.asp) method records the newest units as those sold first. Businesses can simplify the inventory costing process by using a [weighted average cost](https://www.investopedia.com/terms/a/averagecostmethod.asp), or the total inventory cost divided by the number of units in inventory.

## What's the Difference Between a Perpetual Inventory and a Periodic Inventory System?

A perpetual inventory system uses point-of-sale terminals, scanners, and software to record all transactions in real-time and maintain an estimate of inventory on a continuous basis. A periodic inventory system requires counting items at various intervals, such as weekly, monthly, quarterly, or annually.

## What Does COGS Stand For?

COGS is an acronym for cost of goods sold. It plays an integral role in business accounting by providing a point-in-time estimate of the cost to produce products sold by a company. If the company utilizes a perpetual inventory system, COGS is available on a continuous basis. With a periodic inventory system, COGS is calculated at the end of an inventory period.

## What's the Difference Between FIFO and LIFO?

FIFO (first in, first out) refers to an accounting system that assumes the oldest products are sold first, followed by newer ones. LIFO (last in, first out) assumes the most recent products are sold before older ones.

## The Bottom Line

Perpetual inventory systems are preferred in modern business due to their ability to provide real-time data and integration with other business processes, making them less labor-intensive in the long term. There are initial implementation costs of perpetual inventory systems, but they offer potential cost savings and time efficiency over time. This makes them especially well-suited for larger companies with high inventory turnover. One risk is that the perpetual system has an inability to fully account for loss, breakage, or theft. Companies often supplement it with periodic physical counts to maintain accuracy.

Smaller businesses or those with straightforward inventory needs might still rely on periodic systems or lower-cost perpetual systems due to budget constraints. The choice between periodic and perpetual inventory systems depends on the size, complexity, and budget of a company. Larger businesses generally benefit more from the comprehensive data offered by perpetual systems.

> **Article Sources**
>
> 1.  U.S. General Accounting Office. "[Executive Guide: Best Practices in Achieving Consistent, Accurate Physical Counts of Inventory and Related Property](https://www.gao.gov/assets/gao-02-447g.pdf)." Pages 20-21.