Retail business owners do not utilize retail inventory methods, but few companies benefit from the use of this formula, and they include-
- Companies with many locations
- Firms with a large amount of stock/inventory handy and much more.
Questions like; how much retail inventory do I have left, and what is the total value of my products? These give rise to the need for a retail inventory method of calculation.
What Is The Retail Inventory Method?
The retail inventory method is an accounting method used to estimate the value of products in a store at the end of a business period.
Understanding this method aids you in keeping track of your sales, managing the cost of inventory, and the quantity of merchandise, and making it to the hands of consumers against those stolen, missing, or broken.
What Is The Costing Method?
The costing method helps set the company’s standards, fix the price of different products, tariff plans, cost control, and much more. The focus point of the costing method is to control the cost of the goods and increase the efficiency rate, hence yielding more profit.
This method is for two unique purposes: internal and external reporting
Our emphasis is on external reporting. At the end of every reporting year, it allocates prices to the inventory on the balance sheet of any company, thereby calling for the use and application of a cost allocation.
Types And Importance Of Costing Method
There are two primary types of costs experienced by retail business owners, and they are;
- Fixed costs
- Variable costs
Fixed Costs
Fixed costs are also known as overhead costs. It does not change with output, even if the business faces any loss.
Variable Costs
In the costing method, variable costs change in line with the percentage of profit yielded that year, ranging from the cost of labor to the cost of materials, increasing as the volume of production increases.
Formulas With Examples On How To Solve The Retail Inventory Method
Following the four steps listed below, as a business owner, you can calculate and ascertain the value of goods/products still available for purchase in your inventory after a business period.
Step 1 – Calculate the cost-to-retail percentage.
Firstly, you must find the cost-to-retail percentage of your retail inventory.
To do that;
Formula-
Cost-to-retail percentage = (Cost of goods ÷ Retail price of the goods) x 100
For example, if you purchase a good for $50 and then sell it at $100. What is your cost-to-retail percentage?
Cost-to-retail percentage = (50 ÷ 100) x 100
= 50%
Step 2 – Calculate the cost of goods available for sale
Secondly, you need to find the inventory cost at the beginning of the specific time you are calculating. Afterward, you will need the cost of any extra inventory purchases made throughout that business period.
Formula-
Cost of goods available for sale = (Cost of your beginning inventory + Cost of purchases)
An example could be that your retail store has a beginning inventory of $10,000, and then you purchased $22,000 worth of new products. What is the cost of goods available for sale?
Cost of goods available for sale = ($10,000 + $22,000)
= $32,000
Step 3 – Calculate the cost of sales during the period
Thirdly, calculating the cost of sales helps illustrate the total spending it took to sell your products.
Formula-
Cost of sales = (Sales during the period x Cost-to-retail percentage)
Let us use the results from step 1: the cost-to-retail ratio is 50%. Assuming we have sales of $55,000 during the same period. What is the cost of sales?
Cost of sales = ($55,000 x 50%)
= $27,500
Step 4 – Calculate ending inventory
Fourthly, an ending inventory represents the value of the stock you have left at the end of your business period. You are to include the ending stock balance sheets you create and ensure their accuracy.
Formula-
Ending inventory = (Cost of goods available for sale – Cost of sales during the period)
Using examples from the previous results on steps 2 and 3,
Ending inventory = ($32,000 – $27,500)
= $4,500
The Benefits Of Using The Retail Inventory Method
- Easy to Calculate – With the four simple steps, the retail inventory method formula is easy to calculate manually and automatically using software tools.
- Real-Time Generation on Stock Values – Small businesses with inventory management systems can program the calculation to generate new metrics when new data arrives. Giving retailers access to updated stock values.
- Profitable and Simple to Utilize.
- Control Over Your Inventory
The Drawback Of Using The Retail Inventory Method
- Relying on Past Data.
- Results from the retail inventory method can never compete with the physical counting of inventory.
- One other disadvantage is that the formula only works if the retail business owner maintains a consistent markup across the items measured. If the cost of the goods is changed, the inventory needs recalculation. An example of such that can alter this formula is an after-holiday sale (carried out after the close of business and calculation done).
Who Should Adopt The Retail Inventory Method?
- Companies with many locations
- Firms with a large amount of stock/inventory handy and much more
- Retailers who are satisfied with calculations that are available to them on-demand based on the size of their store
With Vencru, the best invoicing and accounting software for your business retailing or wholesale purposes. Vencru app is one of the best tools to grow your retail business and effectively manage your inventory, with easy-to-use accounting and POS software.
Final Takeaway
The retail inventory method is an accounting method used to estimate the value of products in a store at the end of a business period.
There are four steps to calculating the retail inventory method, and they are;
- The cost-to-retail percentage
- Cost of goods available for sale
- The cost of sales during the period
- Ending inventory
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