Inventory is EVERYTHING! It is what will generate the cash to make your business hum. Keeping up with it may not be sexy or fun like marketing can be, but it is crucial in order to have a successful ecommerce business. As we work on “renovating” the accounting system for clients, we are often asked to explain the difference between the Profit and Loss statement that we generate and the one created in their inventory system. A few of the typical issues we uncover are:
- Products/SKUS are missing from the inventory system;
- Costs are not loaded into the inventory system;
- Costs were loaded into the inventory system when the product was new, but not adjusted as the costs changed in subsequent orders;
- There is a mismatch between the costs considered in developing the product costs and the method in which those costs are handled in the accounting system; and
- Write-downs of lost or damaged products were never made in your accounting system.
Make a Date with Your Inventory!
As with any important relationship, you need to be sure you’re taking care of your inventory. How about blocking time on your calendar for a “date” with your inventory? Do it NOW! Make a date with your inventory preferably once a month, but at least once a quarter, and add it to your calendar. It will be just you and your inventory. A time to take an intimate look into your inventory issues.
What Will You Do on Your Date?
Here are some fun activities (ok, maybe not fun, but at least worthwhile) for you to do with your inventory to better understand it and to get the inventory and accounting systems in sync:
- Issue: Product/SKUs are missing from the inventory system.
Activity: This can occur if you have paid for a new product and recorded it in your accounting system as inventory, but the product has not been received in your warehouse or at Amazon. A typical scenario is when the supplier requires 30% down, and that is paid from the inventory account. Perhaps even the complete amount has been paid, along with the shipping costs, and the product is on a boat for 60 days coming from China. If these payments are coded to inventory in the accounting system, but not showing in the inventory system, there is a big disconnect. The way to manage this is to code the payments in the books to a prepaid account. This is also an asset account on the books, but it is not expected to match the value of available inventory. Once those goods are received into your system, move them to the Inventory account using a journal entry.
- Issue: Costs are not loaded into the inventory system.
Activity: It’s easy to skip over this step when you’re in a hurry to get product into Amazon or on your website. You have all good intentions of going back tomorrow once you crunch the numbers and load the costs into the system. Of course, a million other more pressing issues come up and tomorrow is pushed out a day, and maybe another, until this task is in the far back corners your mind. To prevent this from happening, run a report from your inventory system and sort it by product costs, ascending. Those zero cost items will be sitting at the top ready for your full attention.
- Issue: Costs were loaded into the inventory system when the product was new, but not adjusted as the costs changed in subsequent orders.
Activity: One thing is certain; prices will change. If they go up or down, they will not match the activity in your accounting system if you fail to change the costing rates in your inventory system. When you’re on your date with your inventory, spend some time exploring this issue as well. Run a report from your accounting system to show all new payments paid against the inventory asset account. Then look up those vendor invoices and compare them to prior invoices. If there are differences, you need to update your product costs. The trick here is the timing. If you have 1000’s of products in the system at old prices, then update the system with the new prices when those have sold through. A good inventory management system helps make this easier. Staying on top of it monthly will also make it easier.
- Issue: There is a mismatch between the costs considered in developing the product costs and the method those costs are handled in the accounting system.
Activity: We see this often with prep center costs or shipping. When doing the analysis prior to purchasing the product, everything is considered—the price of labels and boxes, and shipping, etc. However, when doing the accounting, shipping is not considered an inventoriable costs and hits the Cost of Goods Sold (COGS) account as a period expense. If you keep shipping in your product costing rates, it will cause a significant difference as these products sell through and you’re relieving inventory for those sales and charging the Cost of Goods Sold. Essentially, you’re expensing your shipping twice and of course, this will have a negative impact on your gross margin. Make sure you have a clear process for developing your cost rates and communicate that with your accounting team.
- Issue: Write-downs of lost or damaged products were never made in your accounting system.
Activity: If you are booking COGS each month based on the unit costs multiplied by the units sold, you will need to “true-up” at least quarterly. If you sell a large volume, I recommend going through this process monthly. Just as your inventory system records what is sold and that information is used to make the calculation mentioned above, it also tracks what is on hand. At first glance, you may think that the inventory on hand is just what you started the month with, less what you sold, plus any new purchased added to the system. That’s the basic concept and works in a perfect world. In the inventory world, we have lost or damaged products that must be counted. Typically, this occurs in your inventory system, but is not necessarily visible in the accounting system. If there was no external banking transaction, it will be invisible to your accounting team unless you make it part of your internal processes.
To perform a “true-up” simply look at the inventory value on hand. This should match your accounting system’s inventory account balance. If it doesn’t, and you have taken all the steps above and have confidence in your costing and timing for recording inventory, etc., then you need to make a journal entry adjustment to make the two balances match. Again, this is done once you’ve taken out all the other noise in the system as mentioned in each of the items above. The journal entry will be needed to adjust Inventory and the offsetting entry will be COGS. Once you make this write-off, your Profit and Loss will be impacted. Take a look and see if it makes sense. If not, dig deeper to understand why that write-off was needed. Were there really lost products or products that were unsellable and had to be destroyed, etc.? As with any process, this will get easier the more attention you give to it over time.
Keep That Relationship Going!
Inventory is the same as cash in that they are both the lifeblood of your business. They both deserve your attention. We’ve had clients who knew something was off with their inventory because they didn’t have the cash that their inventory management system indicated they should be generating based on the profitability shown in that systems. We’ve also worked with folks who went from profits to losses when this was corrected. It’s no fun being the voice of reality, but typically, clients know in their gut that something isn’t adding up. If that’s you, take off the rose-colored glasses and take your inventory on a date where you really get to know it!
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Interested in Profit First?
If your ecommerce business isn’t where you’d like it to be in terms of profitability, check out my book, Profit First for Ecommerce Sellers. It answers important questions about how to implement Profit First in an ecommerce business. Take control of your money and your business, and put Profit First to work for you!
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