Proper inventory control is a core function for healthcare’s supply chain and is a critical contributor supporting an organization’s need for clinical and business operations excellence.
Establishing inventory structure within the hospital/health system is essential to effectively manage inventory and control the movement of products. Supply chain and finance leadership will work together with departments to determine the appropriate structure that provides the greatest benefit for the organization.
There are two primary methods for controlling inventories in healthcare settings:
- Perpetual inventory (asset inventory)
- Periodic auto-replenishment (PAR) (expensed inventory)
PAR inventory relies on an occasional physical count of the inventory to determine the ending inventory balance and the cost of goods sold, while the perpetual inventory system keeps continual track of inventory balances.
There are several differences between the two inventory systems, and we’ll look at the advantages and disadvantages below.
- Perpetual – Under a perpetual system, there are continual updates to either the general ledger or inventory journals, as inventory-related transactions occur.
- PAR – Under a PAR inventory system, there is no cost of goods sold (COGs) account entries in the accounting period until a physical count is performed, which is then used to derive the COGs and update the inventory system.
- Perpetual – It’s impractical, perhaps not possible, to manually maintain the records for a perpetual inventory system because there will be thousands of transactions at the business level in every accounting period.
- PAR – The simplicity of a PAR inventory system allows for the use of manual record-keeping for very small inventories.
Cost of Goods Sold
- Perpetual – Under a perpetual system, there are continual updates to the COGs accounts as each sale is made.
- PAR – Under a PAR inventory system, the COGs are calculated in a lump sum at the end of the reporting period by adding total purchases to the beginning inventory and subtracting ending inventory. For PARs, it can be difficult to obtain a precise COGs amount before the end of the reporting period.
- Perpetual – Cycle counting is essential and required for maintaining a perpetual inventory system.
- Cycle counting benefits:
- Regularly validates the accuracy of inventory
- Reduces disruption of operations
- Reduction in errors
- Allows for the periodic/annual reviews of each product line or segment of products resulting in more confidence in buying decisions
- Adds greater insight to improve inventory turnover
- Provides greater detail to analyze items to be stocked and marked obsolete
- Improves customer service
- Cycle counting benefits:
- PAR – Cycle counting under a PAR inventory system is not possible because there is no way to obtain accurate inventory counts in real time (which are used as a baseline for cycle counts).
- Perpetual – Under a perpetual system, inventory purchases are recorded in an asset/liability account, while there is also a unit count entry into the individual record kept for each inventory item.
- PAR – Under a PAR inventory system, all purchases are recorded into an expensed account, and there are no individual inventory records to account for unit cost information.
- Perpetual – Under a perpetual inventory system, researching inventory errors is easier because all transactions are available in detail at the individual item level.
- PAR – It’s nearly impossible to track and manage the accounting records under a PAR inventory system to determine why an inventory-related error of any kind has occurred because the information is aggregated at a very high level.
When comparing the two, the advantages of a perpetual inventory system are obvious. Tracking item flow in real time allows for close monitoring of stock levels. In most hospital inventory configurations, a combination of both perpetual and PAR inventory settings is necessary to help prevent item shortages and control inventory spending.
A case could be made for not using a perpetual inventory where a PAR inventory makes sense, as when the amount of inventory is very small. Also, you can visually review/maintain it without a need for detailed inventory accounting records.
The supply chain team at Impact Advisors works closely with hospitals and health systems that utilize both inventory control methods. Our expertise in this area helps our customers determine which approach or combination of inventory systems is the best fit for any organization.