Key Concepts
A trading business needs to hold sufficient inventory to meet customer demand while avoiding the problems of holding too much inventory.
| Problem | Cause | Consequence |
|---|---|---|
| Too little inventory | Under-ordering | Stock-out situation — the business runs out of goods and loses sales |
| Too much inventory | Over-ordering | Higher storage costs; risk of goods becoming obsolete (outdated and unsellable) |
To balance these risks, businesses use a perpetual inventory recording method — a computerised record-keeping system that tracks every change in inventory in real time. Each purchase, sale, and return is recorded immediately, so the inventory balance is always up to date.
Besides keeping accurate records, a business also manages its inventory by storing it securely (e.g. in a warehouse) and insuring it against loss or damage.
"Always up to date." The word perpetual means continuous. Under this method, the inventory account is updated after every single transaction — not just at the end of the period.
Confusing stock-out with over-stocking. A stock-out means the business has no inventory — not that it has too much. A stock-out causes lost sales; over-stocking causes higher storage costs.
Thinking obsolescence only applies to technology. Obsolete means outdated and unsellable — and any good can become obsolete, not just electronics. Food can expire, fashion can go out of style, seasonal goods lose demand. This is why holding too much inventory is risky.