When using a periodic inventory management system, you take physical counts of your inventory only periodically (hence the name). So if you take a physical count of your inventory at the end of each month, quarter, or year, this may be a good option for your business.
For many small businesses, this method makes a lot of sense. After all, if you maintain small inventory levels and stock a limited number of sellable products, it should take you only a couple of hours to tally the number of items on your shelves and calculate how many items you’ve sold.
The trouble with periodic systems, though, is that they don’t track inventory on an item-by-item or transaction-by-transaction basis. For starters, that makes it hard to identify accounting errors when they occur, and you can’t track product movement with as much accuracy as you could with a perpetual inventory system. But most importantly, periodic systems make it harder to accurately calculate your cost of goods sold (COGS).
To determine your business’s profitability, you’ll need to know how much you spent to produce, ship, store, and manage the inventory you’ve sold. The problem? Those costs can vary depending on the number of items you order at a time, the amount of inventory sitting in your warehouse, how tightly packed your shipping containers are, and the time spent processing new shipments.
Because periodic systems don’t track individual items and transactions, business owners have to calculate their cost of goods sold by adding the cost of their starting inventory to the cost of any additional inventory ordered, then subtracting the cost of their ending inventory at the end of the period:
Cost of goods sold = Beginning inventory + additional inventory - ending inventory
To determine the costs of your beginning, additional, and ending inventory, you have to keep careful track of purchasing and manufacturing costs for each order, the labor hours spent processing each batch of new inventory, and the amount of time each batch sits in storage. Then you’ve got to track which items actually get sold to determine the actual profit margins on each sale.
Sound complicated? That’s because it is. Granted, an inventory management software can automate a lot of those calculations, but there’s still a big margin of error—especially if your business stores a lot of inventory or offers more than a few product varieties.