Warehousing & Fulfillment

Perpetual Inventory System Explained: Best Practices and Advantages

Warehousing & Fulfillment
December 8, 2021
8 min read

Learn how a perpetual inventory system can improve customer experiences, decrease inventory carry costs, and simplify your inventory management.

As small-to-medium-sized businesses grow beyond in-house fulfillment, most consider using a perpetual inventory system to ensure optimal stock is on-hand to keep up with demand without overpaying for storage. 

Inventory is often SMB’s largest asset and managing it effectively makes or breaks the business. Gone are the days where in-store loss prevention was the central focus for reducing inventory shrink. Today’s multichannel sellers understand that most loss is preventable, such as damage, administrative errors, and dead stock

Along with increasing profitability, implementing a perpetual inventory system is a crucial cog in future proofing the business against preventable loss. 

But how do emerging companies put a perpetual inventory system in place? Where should they begin? 

Below we go into greater detail on how perpetual inventory systems work and what differentiates them from other inventory systems.

What is a perpetual inventory system?

A perpetual inventory system is a supply management program where inventory changes in real-time based on electronic records – not physical stock. Starting from a baseline of physical count, sales and inventory purchases are reordered immediately via integrated computerized point-of-sale (POS), enterprise asset management (EAM) software, and inventory management systems. Accordingly, stock counts are updated as soon as employees use barcode scanners to record purchases and returns.

With this knowledge, inventory accounting is much more accurate – and cost of goods sold (COGS) is recalculated automatically in real-time. Further, decision makers have detailed reporting of inventory changes, including quantity of goods on hand at the stock keeping unit (SKU) level. This avoids costly stockouts and allocating marketing dollars away from fast moving products due to human error caused by manually keeping detailed inventory records. 

How does the perpetual inventory system work?

Perpetual inventory systems function by updating stock counts instantaneously as goods arrive in the warehouse and are purchased by customers. 

Step One – POS System Refreshes Inventory Levels

When goods are sold, the inventory management system, which is integrated with the POS system, immediately debits the stockpile count across all sales channels. This is much easier for sellers who have incorporated SKUs down to individual product variants. 

Step Two – Automated Update of Cost of Goods Sold (COGS) 

COGS are recalculated as soon as product is received or sold, helping finance, accounting, and executive update pricing and take other steps to improve profitability

Step Three – Optimal Level of Inventory Maintained

Powered by active demand forecasting, the perpetual inventory management system automatically re-orders items as sales rise and decline. The result is maintaining an optimal level of inventory at all times – especially the most profitable goods. 

Step Four – Automate Purchase Order Generation

When SKUs hit the automatic reorder point, new purchase orders are generated and sent to suppliers with no manual processes. 

Step Five – Receive Merchandise and Scan In Inventory

Employees scan product as it arrives in the facility using warehouse management software (WMS). This makes the newly arrived goods appear in the inventory management dashboard and available for purchase across the entire multi-channel marketplace.

What’s the difference between a perpetual inventory system and a periodic inventory system?

Both perpetual inventory and periodic inventory systems monitor and track stocked items, but they’re very different. 

Also known as a noncontinuous system, periodic inventory systems are kept updated by physically counting all goods at certain times or cycle counting. The latter is when only portions of inventory are counted with the intent of accounting for all inventory over a particular time frame. Typically, stock is tallied at the end of an accounting period or financial year to create reports and calculate COGS using inventory valuation methods such as last in first out (LIFO), first in first out (FIFO), and weighted average = cost (WAC)

Consequently, periodic systems perform better for sellers not affected by slow inventory update. This makes emerging SMBs with few SKUs, storefronts, and longer sales cycles the best candidates. As they expand, SMBs should evolve to a perpetual inventory system, but the fact they’re focused on maintaining accurate inventory counts and inventory days on hand out of the gate is already a step in the right direction.

On the other hand, perpetual inventory systems are much more advanced. They continually update inventory counts as goods are bought and sold. Plus, they centralize inventory information, making data available to all parts of the business. As a result, perpetual inventory systems are suited more for multi-channel retailers with high sales volume across several locations and storefronts. 

What are the 7 advantages of a perpetual inventory system?

A perpetual inventory system has 7 key advantages over the older periodic inventory system:

  1. Updating Accounts in Real-Time – Inventory changes are recorded automatically across all sales channels, creating an optimal customer experience. For example, a perpetual inventory system makes hammer shoppers confident that the specific hammer they want is available online and will arrive in the guaranteed shipping time. Or the hammer they’d like to buy in person at a store nearby will be there, eliminating the need to drive around town searching.
  2. Ability to Integrate with Other Business Systems – Perpetual inventory software makes key real-time inventory data available across the entire organization. Integrating inventory management with financial systems ensures proper regulatory and tax reporting – along with calculating end-of-year inventory balance automatically. Also, eCommerce and sales teams can provide a better shopping experience with accurate inventory and shipping information at their fingertips.
  3. Reduced Inventory Management Costs –With optimized holding costs and replenishment, storage fees are dramatically reduced. Automated processes reduce labor costs, as well, since less manual work is required relying on a perpetual inventory system. 
  4. Instantaneous Adjustments to Cost of Goods Sold – A running tally of transactions is kept in a perpetual inventory system, so updated COGS are always available.
  5. Capitalizing on Inventory Forecasting and Future Demand – Forecasting demand is much simpler using a perpetual inventory system. Historical inventory counts are much more accurate than if they were added up manually. Combined with sales data, AI and machine learning analyze historical sales patterns to determine when, how much and where to forward stock inventory
  6. Improved Return on Advertising Spend (ROAS) – Knowing exactly what inventory is on hand at the SKU level, marketers can confidently run promotions to sell slow moving goods or ramp up advertising spend to push popular items. Companies can squeeze the most return on investment (ROI) out of their marketing dollars without sacrificing customer experience. 
  7. Easier Investigation of Errors – Perpetual inventory systems track inventory throughout the entire eCommerce supply chain and leave a paper trail. This makes conducting investigations into inventory errors after the fact much simpler. 

The Bottom Line

ECommerce companies should opt for a perpetual inventory system over a manual periodic inventory system to take advantage of centralized stock management, among many other benefits. 

For SMBs this technological lift is often easier said than done, which is why most partner with a fourth-party logistics (4PL) provider to handle the heavy lifting of multichannel fulfillment. UPS’s Ware2Go is a 4PL that helps businesses of all sizes leverage best-in-class fulfillment and inventory management tools to forecast demand, optimize reorder points, and set stock levels.

To learn more about how Ware2Go can help you manage inventory more effectively, please reach out to one of our fulfillment experts.

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