Two systems for tracking inventory
Every business that sells goods needs to know how much remains in its inventory and how much the goods it sold cost. There are two basic ways to record this:
- Periodic inventory system: purchases are recorded in a purchases account, and the inventory balance is not updated with each sale. At the end of the period, inventory is physically counted, and cost of goods sold is derived as the difference.
- Perpetual inventory system: the balance of each item is updated in quantity and value with every purchase, sale or return, so cost of goods sold and the inventory balance are known at any moment.
The calculation under a periodic system
The formula: Cost of goods sold = Opening inventory + Net purchases − Closing inventory (per physical count).
The problem is that any shortage, theft, damage or issuing error disappears inside cost of goods sold without you seeing it. You see a single figure, and you do not know how much of it is actual sales and how much is loss.
Example: one pharmacy under two systems
A pharmacy in Abha, annual data at cost:
| Item | SAR |
|---|---|
| Opening inventory | 80,000 |
| Net purchases | 300,000 |
| Available for sale | 380,000 |
| Closing inventory per physical count | 95,000 |
Under the periodic system: Cost of goods sold = 380,000 − 95,000 = 285,000 SAR. That is the end of it, with no further information.
Under the perpetual system: the system recorded the cost of each item when it was sold, so recorded cost of sales came to 280,000 SAR, and the expected book balance was 100,000 SAR. The physical count found only 95,000 SAR.
| Item | SAR |
|---|---|
| Actual cost of sales | 280,000 |
| Inventory shortage | 5,000 |
| Total | 285,000 |
The same total, but the perpetual system revealed that 5,000 SAR was not sold but lost. And because the system tracks each item, you can find out that most of the shortage is in specific items, such as cosmetics near the cashier or expired medicines that were not recorded as damaged, so the remedy can be targeted.
Quick comparison
| Aspect | Periodic inventory | Perpetual inventory |
|---|---|---|
| Knowing the balance | At the end of the period only | At any moment |
| Cost of sales | As a difference at the end of the period | With every invoice |
| Detecting shortages | Almost impossible | By comparing book with actual |
| Requirements | Simple | A system, item coding and disciplined data entry |
| Monthly financial statements | Require an estimate or a monthly count | Available directly |
Which one suits you?
A periodic system may be enough for a very small business with few low-value items, run by the owner personally, that does not need accurate monthly reports.
A perpetual system is the practical choice in the following cases:
- A large number of items, as in pharmacies, auto parts stores and supermarkets.
- High-value items or items that are easy to steal.
- Items with expiry dates or batch numbers that need tracking.
- Several branches or warehouses that need transfers between them.
- A need for reorder decisions based on the actual balance.
Moving from a periodic to a perpetual system requires preparation: coding each item with a unified number or barcode, an accurate opening count to serve as the starting point, and training staff to record every movement without exception, including returns, damaged goods and free samples. Any movement that is not recorded later turns into a count difference that is hard to explain. It is best to start with one item category or one branch, then expand once you are sure the procedures are being followed.
Note that the choice of inventory system is independent of the valuation method. Weighted average cost or FIFO can be applied under either system, but a perpetual system needs the cost calculated at each sale, which is why it usually uses the moving average.
Cycle counting: the middle ground
With a perpetual system, you do not need to close the store for a whole day to count. You can apply partial periodic counting (Cycle Counting): count a group of items every week, with the greatest focus on high-value or fast-moving items, so that every item is counted at least once during the year, and shortages are detected when they occur, not months later.