If you sell products of any kind, you need to know how to take inventory and you need to do it at the end of each year.
Why should I take Inventory?
If you sell products, it is REQUIRED that you provide inventory information on your taxes. It is called Cost of Goods Sold and calculates your taxable income.
I talk about the difference between cash flow and profit often. Most people count all the money they spend as an expense. That is incorrect. Expenses are only things that are ‘used up’ in your business. Office supplies and things you need to do your job everyday are expenses. Inventory is not.
Inventory is not ‘used up’ in the ‘ordinary course of business’. You buy inventory (turn cash into products) then you turn around and sell them, hopefully at a markup (you turn your products back into cash). Your inventory is an asset, which means it is worth something and can be sold. It is not an expense.
What is Cost of Goods Sold?
Many bookkeeping programs have a category of ‘Cost of Goods Sold’ which is an expense. It is super easy to put everything in Cost of Goods Sold, but it records it as an expense, and that is incorrect. No matter what the software tries to do, it is still wrong. I have not found a bookkeeping software that makes you do it correctly. You cannot expense everything you buy.
How do I deduct what I spend on inventory?
You deduct the cost of your inventory when it is sold. That is why is it called “Cost of Goods Sold” and not cost of goods that maybe I can sell later. Technically, it is the same calculation as capital gains. You buy something. You sell it at a higher price. The selling price minus what you paid is your profit.
That’s too complicated!
Yes, it is. Unless you are selling houses or restoring cars, it is too complicated to calculate your gain on every single piece of inventory. A restaurant cannot figure where every piece of lettuce went. Most small businesses can use a little math for calculating your Cost of Goods Sold. I’ll try to make it easy. Here’s the math:
Beginning Inventory (left over from last year)
+ Inventory Purchases this year
__________________________________________________
= Total Inventory
– Value of Current Inventory (what you haven’t sold yet)
___________________________________________________
= Cost of Goods Sold
What about things that were stolen or broken?
When you add up what is left at the end of the year, this is the time to discard expired or broken products you cannot sell as your brand. You can also put them on sale or sell them off another way. Dispose of unsellable things at the end of the year and do not include them in your final inventory figure. That increases your Cost of Goods Sold deduction and that is how it is ‘written off’. Things removed from inventory due to breakage, theft, staleness, etc., are considered part of the ‘ordinary course of business’. Things that are removed only for personal use are owner draws.
How often do I take inventory?
You need to take inventory once a year to do your taxes. You can do it once a month or once a quarter if you want to track costs, but it takes time and effort. Most people do it once a year or when they need up-to-date financial statements for a bank loan or something else unusual.
How to Take Inventory
- Get people to help you. Employees, family, friends, or anyone willing to help. Supplying appropriate adult beverages helps. (Coffee!)
- Download my inventory sheet and print several copies.
- Pick a room or area to start. (the walk-in. the freezer, the back bar, the shed) Label the sheet. This is where you need the help.
- Start anywhere and work your way around the room in one direction, top to bottom.
- List the product, size and how many of each on the sheet. If you have partial containers, usually listing by half package is sufficient unless it is something very expensive.
- Once you have all your inventory on sheets, collect the sheets and thank your helpers. Give them a Christmas bonus.
- If you buy things from multiple suppliers, split what you have in stock between the suppliers as you feel is correct.
- Figure the price your PAID for everything in stock. This is hard for things that change price a lot. You need to reflect what you actually paid for what you have in stock. Come as close as you can, but do not lose sleep over it.
- Additional costs: This is sales tax you are paying, delivery of your items, and any costs for improving our items such as custom labels. All that is part of inventory.
- The rest is math. If this is overwhelming, and I know for some people it is, ask for help. Give the sheets to your tax preparer and have them add it up. We are good at math. You need to count everything and gather the prices you paid. We can figure the total for you.
Download the Inventory Worksheet here!
