Cost benefit analysis is a management tool that is used when determining how well or how poorly an action will turn out to be if undertaken. Managers in their daily functions are faced with complex managerial problems that require proper analysis of the available actions. For in stance, a production manager would be in dilemma as whether to hire additional production staff or work overtime to meet a given target. The answer to these decisive situations can be found through cost benefit analysis.
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To carry out a cost benefit analysis, one is required to list down all the benefits (positive factors) and the costs (negative factors) which then are summed and to find the net benefits. This paper presents a dilemma: a perpetual inventory count or the annual stock check.
In Perpetual stock count, (continuous Inventory) “information on stock availability and quantity is updated in a day-to-day basis” (Boardman, Greenberg, Vining, & Weimer 2005 p. 67). Annual stock check (periodic inventory system) on the other hand, does not require a frequent update on the quantity or availability of stock but rather this is done at the end of the year (Nas 1996 p.136).
The actual inventory at the end of the period is established by physical count and this figure is used in computing the amount of stock sold (Hadley & Whitin 1963 p.224). The two systems possess a range of advantages and disadvantages, as enumerated below.
|Perpetual inventory system||Annual inventory check|
|Cost of goods sold and inventory accounts are updated daily and maintained all through the year |
Purchases made are reflected in the inventory account.
Purchase return account is not maintained such is reflected in the inventory account.
Inventory is modified after every single sale deal made.
Goods returned after sale lie in the inventory and their sale value subtracted from the total cost sale value.
|Inventory and Cost of goods sold accounts are not prepared until the end of the year |
Keeps a purchase account for recording purchases made
Keeps a purchases returns account for the purchases returned.
The value of sales is settled at end of year.
It does not maintain an account for goods returned after sale.
For proper analysis of the two methods, the down listed benefits and costs should be considered.
Perpetual inventory system
- Quantity of stock can be established easily saving on human capital costs.
- Interim accounts can be prepared fast helping management in decision-making.
- It reduces stock theft.
- It helps reveal discrepancies and errors for timely corrective measures.
- It helps in proper stock maintenance thus no losses due to over/under stocking
- The system will require purchase of computer and accessories
- Training costs for staff members
- Computerization will attract insurance premiums.
- Annual stock check method
- No many records maintained thus reduces record keeping costs
- The gaps that exist in stock value estimations make it hard to budget and assess revenue at any time a part from around the stock check time. Posing high risks when a company experiences disasters and is seeking compensation from the insurer.
- It is not easy to establish stock movement since such details are not available, thus not easy to control theft.
- Cannot help in detection of obsolete or deteriorating stock
From the above discussions and analysis it becomes evident that the periodical inventory count could be ideal in small businesses whose costs of installation of the computerized system would definitely outweigh the benefits. On the other hand, the perpetual inventory would lead to significant benefits in a large company, whose costs of installation of the system and of training will be offset by the ultimate benefits, which include curbing stock theft, fast decision making, early revelation of errors, and proper stock maintenance.
Boardman, A, Greenberg, H, Vining, A, & Weimer, D 2005, Cost Benefit Analysis: Concepts and practice, 2nd edn, Prentice Hall, New Jersey.
Hadley, G, & Whitin, TM 1963, Analysis of Inventory systems, Prentice Hall, New Jersey.
Nas, T 1996, Cost-Benefit Analysis: Theory and Application, Sage, Thousand Oaks, CA.