A Comparison of the Perpetual and Periodic Inventory Systems

Beginning inventory plus net purchases during the period is the cost of goods available for sale. The main difference between a perpetual and a periodic system is that the periodic system allocates cost of goods available for sale between ending inventory and cost of goods sold (periodically) at the end of the period. In contrast, the perpetual system performs this allocation by decreasing inventory and increasing cost of goods sold (perpetually) each time goods are sold The impact on the financial statements of choosing one system over the other generally is not significant. The choice between the two approaches usually is motivated by management control considerations as well as the comparative costs of implementation. Perpetual systems can provide more information about the dollar amounts of inventory levels on a continuous basis. They also facilitate the preparation of interim financial statements by providing fairly accurate information without the necessity of a physical count of inventory. On the other hand, a perpetual system may be more expensive to implement than a periodic system. This is particularly true for inventories consisting of large numbers of low-cost items. Perpetual systems are more workable with inventories of high-cost items such as construction equipment or automobiles. However, with the help of computers and electronic sales devices such as cash register scanners, the perpetual inventory system is now available to many small businesses that previously could not afford them and is economically feasible for a broader range of inventory items than before. A perpetual system provides more timely information but generally is more costly.

The periodic system is less costly to implement during the period but requires a physical count before ending inventory and cost of goods sold can be determined. This makes the preparation of interim financial statements more costly unless an inventory estimation technique is used.2 And, perhaps most importantly, the inventory monitoring features provided by a perpetual system are not available. However, it is important to remember that a perpetual system involves the tracking of both inventory quantities and costs. Many companies that determine costs only periodically employ systems to constantly monitor inventory quantities.

GROSS MARGIN RATIO

What It Measures The gross profit margin ratio measures how efficiently a company uses its resources, materials, and labor in the production process by showing the percentage of net sales remaining after subtracting the cost of making and selling a product or service. It is usually expressed as a percentage, and indicates the profitability of a business before overhead costs. Why It Is Important A high gross profit margin ratio indicates that a business can make a reasonable profit on sales, as long as overheads do not increase. Investors pay attention to the gross profit margin ratio because it tells them how efficient your business is compared to competitors. It is sensible to track gross profit margin ratios over a number of years to see if company earnings are consistent, growing, or declining. For businesses, knowing your gross profit margin ratio is important because it tells you whether your business is pricing goods and services effectively. A low margin compared to your competitors would suggest you are under-pricing, while a high margin might indicate over-pricing. Low profit margin ratios can also suggest the business is unable to control production costs, or that a low amount of earnings are generated from revenues.

To calculate gross profit margin ratio, use the following formula: Gross profit margin ratio = Gross profit margin Net sales First, determine the gross profit for the business during a specific period of time, such as a financial quarter. This is total revenue minus the cost of sales. The cost of sales includes variable costs associated with manufacturing, packaging, and freight, and should not include fixed overheads such as rent or utilities.

ACID TEST RATIO

A stringent indicator that determines whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory. The acid-test ratio is far more strenuous than the working capital ratio, primarily because the working capital ratio allows for the inclusion of inventory assets. Calculated by:

Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Furthermore, if the acid-test ratio is much lower than the working capital ratio, it means current assets are highly dependent on inventory. Retail stores are examples of this type of business. The term comes from the way gold miners would test whether their findings were real gold nuggets. Unlike other metals, gold does not corrode in acid; if the nugget didn't dissolve when submerged in acid, it was said to have passed the acid test. If a company's financial statements pass the figurative acid test, this indicates its financial integrity.

Inventory Turnover Ratio

The inventory turnover ratio is one of the most important financial ratios. Of all the asset management ratios, it gives the business owner some of the most important financial information. The inventory turnover ratio measures the efficiency of the business in managing and selling its inventory. This ratio gauges the liquidity of the firm's inventory. It also helps the business owner determine how they can increase their sales through inventory control. Inventory turnover = Cost of goods sold / ( ( Beginning inventory + ending inventory ) / 2 ) Generally, a high inventory ratio means that the company is efficiently managing and selling its inventory. The faster the inventory sells, the less funds the company has tied up. Companies have to be careful if they have a high inventory turnover as they are subject to stockouts. If a company has a low inventory turnover ratio, then there is a risk they are holding obsolete inventory which is difficult to sell. This may eat in to a company's profit. However, the company may be holding a lot of inventory for legitimate reasons. They may be preparing for a holiday season in the case of the retail industry or preparing for a strike, among other reasons. It is important for a business owner to understand why the inventory turnover ratio is high or low. In order to do that, the owner needs to look at the company's investment in inventory and determine what inventory is being most productive. It is also important to use comparative data such as time series (trend) or industry data with which to compare a company's inventory ratio in order to analyze whether it is too high or too low

Days Sales Of Inventory - DSI

A financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory (including goods that are work in progress, if applicable) into sales. Generally, the lower (shorter) the DSI the better, but it is important to note that the average DSI varies from one industry to another. Here is how the DSI is calculated:

Also known as days inventory outstanding (DIO) This measure is one part of the cash conversion cycle, which represents the process of turning raw materials into cash. The days sales of inventory is the first stage in that process. The other two stages are days sales outstanding and days payable outstanding. The first measures how long it takes a company to receive payment on accounts receivable, while the second measures how long it takes a company to pay off its accounts payable.

Control Principles in Accounting information systems

Information and communication system The purpose of the information and communication system is to help ensure that employees are aware of the unit's goals and objectives, how they are to be accomplished, and who is responsible for the specific tasks to accomplish them. The information and communication system must also provide administrators with reports containing operational, financial, and compliance information to monitor progress toward accomplishing established goals and objectives and to allow administrators to make appropriate decisions. Information and communication systems include: The university's written policies and procedures The unit's goals and objectives The unit's documented policies and procedures Organization charts Position descriptions Performance evaluations Training programs Periodic reports measuring progress toward the accomplishment of goals and objectives An essential part of the internal control system is an effective information and communication system that ensures that employees know what they are supposed to accomplish and how they are to do it.

Senior management is responsible for:

Ensuring adequate and comprehensive internal financial, operational and compliance data; and, Ensuring adequate and comprehensive external market information about events and conditions that are relevant to decision making.

- Senior management is responsible for:

Establishing effective channels of communications to ensure that all staff are aware of policies and procedures affecting their duties and responsibilities; and, Ensuring that other relevant information is reaching the appropriate personnel.

- Senior management is responsible for:

Ensuring that there are appropriate information systems in place that cover all activities of the bank; and, Ensuring that information systems are secure and periodically tested.

The Relevance of Accounting Information

Accounting is a common measuring stick in small business. A business owner can use accounting information to measure her company ;s business and operational performance. Accounting information is usually prepared according to generally accepted accounting principles (GAAP). GAAP is the most authoritative accounting standards in the U.S. GAAP requires accounting information to be accurate, timely and relevant. These features ensure owners have the best information for making business decisions. Relevance Relevance –as defined in accounting terminology-- indicates that accounting information provides a necessary benefit for the end user. End users of accounting information are commonly referred to as internal and external business stakeholders. Internal stakeholders include business owners, managers and employees. External stakeholders include lenders, investors and the general public. External stakeholders use relevant accounting information to make financing decisions for small business loans. Income Statement Business owners need relevant information when reviewing their companys income statement. Relevant information ensures all inventory costs are included in the companys cost of goods sold account. Expenses must also be relevant to the particular sales revenue earned for the accounting period. One-time, non-recurring expensed charges can quickly distort a companys income for the accounting period. Companies must ensure this information is relevant prior to release for review by external business stakeholders. Inventory Relevant accounting information can also help business owners make decisions regarding inventory cost. The inventory cost is relevant because it represents the money a business owner must pay to purchase direct materials for producing goods. Business owners may purchase inventory to resell in a retail business environment. Relevant costs include what companies must pay right now to replace current inventory. Business owners must also pay attention to any volume discounts which can change the relevance of inventory costs. Considerations Business owners should also be sure accounting information is accurate and timely. Accurate accounting information ensures all financial information is recorded properly on the companys accounting ledger. Timeliness refers to accounting information recorded in the proper accounting period. Most small businesses record financial transactions on a monthly basis. Including financial information from previous or subsequent months can distort the current accounting periods information. Seeking Help Small business owners who are unfamiliar with the accounting process should seek outside help or information to learn about accounting. Business owners can take a class at a local college or university to learn about the importance of relevant accounting information. The local chamber of commerce or other business trade association may offer free or low-cost seminars for business owners. These organizations usually offer information on properly running a small business and why accounting information plays an important part in business ownership.