Last updated: February 3, 2023
Inventory management is one of the most crucial (and tedious) parts of the e-commerce business workflow. And thankfully, advances in retail technology are finally making it easier to tackle.
One of the most beneficial has been perpetual inventory systems—tools that can streamline your entire inventory management process, all while ensuring accuracy.
In this article, we’ll be taking a look at perpetual inventory systems—covering what they are, how they work, and how you can implement them alongside other e-commerce management tools like Upscribe to maximize the benefits.
Ready to take the stress out of keeping track of your inventory? Let’s get started.
What is a Perpetual Inventory System?
Let’s start simple—perpetual inventory is an accounting method in which businesses to track the inventory they have on hand in real-time. It’s often contrasted with a periodic inventory, in which stock take is done at set intervals (e.g., daily or weekly).
Perpetual inventory systems are software solutions that businesses use to simplify this accounting method. Instead of staff recording inventory changes manually, perpetual inventory systems use data from point-of-sale (POS) systems, customer orders, subscription management tools, and vendor shipments to automatically update inventory records in real time.
Some perpetual inventory systems stop at simply tracking the inventory on hand, while others also include features like automatic reordering, stock location management, and vendor data integration.
Perpetual vs. Periodic Inventory: Which Is Better for Your Business?
We briefly covered two different approaches to inventory—perpetual and periodic. So which one should you choose?
The answer depends on the size, complexity, and specific needs of your business. Here are two considerations to help guide your decision:
1. Company size
Periodic inventory is usually done manually. For smaller businesses, it won’t take longer than a couple of days to complete a stock take—making periodic inventory a viable option.
But for businesses that deal with high volumes of inventory, manually counting stock is nearly impossible. That’s where a perpetual inventory system comes in. As it tracks inventory levels in real time, staff don’t need to manually count stock every month or week. This saves a lot of time and effort.
The cost of running a periodic inventory system is tied to the wages of your staff and the amount of time it takes them to complete the task. In contrast, perpetual inventory systems involve upfront costs like software implementation, maintenance, and upgrades.
Generally speaking, the larger the business, the more money can be saved by switching to a perpetual inventory system.
Why Use a Perpetual Inventory System?
1. Prevents stockouts
Regular stockouts are one of the most effective ways to drive potential customers into the arms of the competition. It’s estimated that 21-43% of customers will go to another store to buy an item that’s out-of-stock at yours. And many of those customers are gone for good—only around 59% will ever be back.
Perpetual inventory systems minimize the likelihood of stockouts by automating purchases whenever inventory thresholds are reached. This keeps your stock levels up and helps retain your hard-earned customers.
2. Helps understand buyer patterns
Since perpetual inventory systems record stock changes in real-time—after a customer places an order, for example—they can provide insights on your customers and their buying patterns.
This means that business owners can track which factors influence buying decisions. For example, certain items may be more popular at a certain time of year. This allows you to stock a higher volume of those products during those times, ensuring you never face a shortage.
In a nutshell, perpetual inventory systems fine-tune how your business stocks items and ensures that you’re never under or over-stocking.
3. Optimizes storage space
Many businesses that use periodic inventory systems over-order to avoid stockouts. They don’t have access to real-time data for inventory on hand, so they end up storing more items than necessary, using valuable space and resources.
Perpetual inventory systems provide access to real-time changes in stock. This allows businesses to accurately manage their storage capacity, optimize their warehouse space, and save money on inventory costs.
Formulas Used by Perpetual Inventory Systems
Economic Order Quantity (EOQ) is a formula used in perpetual inventory systems that can help to reduce costs and optimize the use of space. It generates the optimum quantity of products to order based on the associated storage and fulfillment costs.
The EOQ formula is:
EOQ =2 product sold annually cost to order productcost to store product
Let’s say your shop sells an average of 500 hats per year. It costs you $3 to store each hat for a year and $2 to place an order. The EOQ would be the square root of (2 × 500 × $2)/($3)—or roughly 26. This tells us that the optimal order size for your hat business is 26 hats at a time.
Cost of Goods Sold (or Cost of Sales) is used to calculate the total cost of products sold during a certain period. This includes all costs associated with the production and sale of those items, including labor, materials and other costs.
The COGS formula is:
COGS =beginning inventory + purchases – ending inventory
Let’s say your hat business starts the quarter with $20,000 in inventory. Over that quarter, you purchase $50,000 in hats and end the quarter with an inventory worth $25,000.
The COGS would be $20,000 + $50,000 – $25,000 = $45,000. This tells us that the total cost of goods sold for the quarter was $45,000. With a perpetual inventory system, COGS is worked out in real-time as products are purchased and sold.
3. Gross Profit Method
Gross profit is a measure of the money earned from the sale of goods, once the costs of producing those goods has been accounted for.
The formula is:
Gross Profit = total revenue – COGS
To continue the example above, let’s say that the total revenue from hat sales for the quarter was $65,000. The COGS equation tells us this quarter’s cost of goods sold was $45,000. The gross profit for the quarter would be $65,000 – $45,000 = $20,000.
First In, First Out (FIFO) is an inventory management method in which the inventory that comes in first is sold first. This method helps to ensure that the oldest products are sold before newer ones and helps prevent spoilage, especially in businesses where product expiration dates are important.
To illustrate, let’s say your hat business purchased two batches of hats during the quarter: one at the start (100 hats worth $20,000) and one at the end (100 hats worth $21,000 due to a supply chain disruption).
Under a FIFO system, the oldest batch of 100 hats will be sold first. This means that the COGS will be calculated on the $20,000 worth of hats rather than the more expensive second batch.
Last In, First Out (LIFO) is the opposite of FIFO. It’s a method of inventory management in which the newest items are sold first. This may be beneficial for businesses where prices are rising, as it means the cost of goods sold can be higher.
To use the same example as before, your business’ COGS would be calculated on the $21,000 batch of hats rather than the $20,000 worth. This means that your COGS would be higher in this instance.
Perpetual Inventory System Best Practices
1. Choose the right software
To make sure your perpetual inventory system provides the greatest value to your business, you need to choose the right software. Some perpetual inventory software will be better suited for some businesses than others.
You’ll need to consider a few of factors when deciding which is best for your business, including:
- Cost: Set your budget right off the bat and filter out tools that don’t fit within it.
- Features: Not all software will offer the same features. Make sure you select one that suits your specific needs.
- Scalability: If growth is your goal, make sure the software you choose can scale with your business.
- Integrations: Last but not least, think about the software you use currently and whether you need your perpetual inventory software to integrate with them.
That last point is huge—perpetual inventory systems are only effective when they have access to all your sales and purchase data. That means it’s important that your business uses tools that collect and share this data easily.
Upscribe is a subscription management platform for e-commerce businesses that offers a suite of tools designed to help you maximize your profits and streamline operations, including:
Oh, it also offers a powerful API that makes integrations with your perpetual inventory system a breeze.
Regular, predictable revenue makes it easier to plan and manage your inventory, and that makes Upscribe an essential supporting tool for your inventory management system.
2. Leverage automation
Whatever software you decide to use, you should look for ways to automate your inventory processes. Automating manual data entry and tracking tasks can save your business time and money and make your inventory system more accurate.
The tasks you can automate will depend heavily on the software you choose, but some common automations include:
- Order management and fulfillment
- Inventory tracking and forecasting
- Reordering based on reorder points
- Reporting and analytics (e.g., calculating COGS)
These automations will help you keep your inventory system up to date, ensuring that you always have the right amount of stock on-hand.
3. Migrate your inventory
Once you start using your perpetual inventory system, it’s important to migrate all of your existing inventory data into the software.
This process will probably seem like a monumental undertaking—and depending on the size of your business, that may be true. But there are a few things you can do to make it easier, including:
- Create a migration checklist: A checklist will help you keep track of where you are in the process and make sure nothing is overlooked.
- Start with less popular items: Begin by migrating the items in your inventory that don’t sell as much. That way, you have time to work out any kinks before you migrate more popular items.
- Block out time each week: Set aside some time each week to work on the migration. Even if it’s just an hour, that time will add up quickly and help you stay on track.
- Run your legacy system in parallel: Running both systems in parallel for a period of time can help ensure that you’ve migrated all your data and everything is running smoothly.
4. Optimize reorder points
Reorder points are the levels at which you order new inventory. Ideally, you want your reorder points to be low enough that you never run out of stock, but high enough that you avoid excess inventory.
Many of perpetual inventory systems have features that allow you to set reorder points automatically based on historical sales data or other parameters. That said, you’ll probably need to fine-tune those settings to get your reorder points just right.
Some factors you should consider include:
- Seasonal demand: Your inventory needs may change depending on the season.
- Lead times: Lead times can vary dramatically depending on your supplier and product. Make sure you’re accounting for them when setting reorder points.
- Safety stock: If you’re dealing with particularly unpredictable demand or long lead times, consider setting a safety stock to ensure that you never run out.
Get Proactive About Managing Your E-Commerce Business
Inventory management is a critical part of running an e-commerce business—and it’s only becoming more complex as businesses grow.
Leveraging a perpetual inventory system and automating as many processes as possible are key to staying competitive. With the right tools in place, you’ll be able to keep your inventory up-to-date and accurate with minimal effort.
And while you’re at it, why not get proactive about managing your subscription business? At Upscribe, we help online businesses design, launch and manage their subscription programs with powerful tools and features.
Schedule a free demo today to learn more!