Most businesses because of the time and expenses involved in taking a Physical Inventory (counting and assigning costs), only take an inventory once a year at the end of their accounting period.
A weakness of using the Periodic Inventory Method is that since no continuous detail records are maintained, the cost of the goods that are sold are not known until a Physical Inventory is taken.Why is this a weakness ? I don't know about you, but I'd like to have a pretty good idea of whether I'm making money during the year and not have to wait until year end to take an inventory to find out !
Without monthly or at least quarterly Profit and Loss Statements as the old saying goes "the horses may all have already gotten out of the barn". You need to have readily available information in order to adjust plans and take any remedial actions needed to insure the profitability of your company. You are in the business to make a reasonable profit aren't you ? Also, no early information is available for tax planning. At the end of your year it's too late to make any decisions and take any actions that might save you some taxes.
So, if I want to prepare monthly or quarterly financial statements (interim statements), what other options are available that don't require a physical inventory ? You can estimate your Ending Inventory. Can you think of any other reason that might require you to estimate your ending inventory ? God forbid, but what if your inventory was destroyed by a fire. It's very difficult to count ashes and determine what goods were destroyed.
Two common methods used for estimating inventories are:
- Gross Profit Method
- Retail Method
What's Next ?
Gross Profit Method