Inventory and COGS – What counts?

When you are trying to determine your product costs, it is often confusing about what to include and where it goes in your financial records.  Let’s break this down.

When you purchase your products and place them in inventory at Amazon or your warehouse, those product costs go into your inventory account.  Any improvement, like labels or packaging also can be added to the inventory account.  Because inventory is an asset that belongs to you, Inventory is tracked on your Balance Sheet.

Balance Sheet Basics:

• Shipping is generally treated as a period cost (incurred and counted in the current period) and added to one of your Cost of Sales accounts to show up on your Profit and Loss statement.
• Inbound shipping (shipping to you) can be inventoried, but doesn’t have to be.
• Outbound shipping is always a period expense.

Most small businesses chose not to inventory any shipping cost, because of the effort required to account for the cost variability from one shipment to the next.

This variability can occur because of shipping methods, expedited shipping costs, changes in fuel costs, etc.  Rather than try to track these variables as inventory, we typically record all shipping directly into the Profit and Loss report as an expense during the period it occurs.

Inventory is reduced and recorded as Cost of Goods Sold (COGS) to match the period in which the sales occur.  The value of the inventory reduced should correlate with the value originally added to inventory.

Depending on your method for tracking your Inventory, it is also necessary to analyze the inventory account on at least a quarterly basis.  Many businesses directly calculate and book their Cost of Goods Sold number every month, reducing their Inventory by that amount.

This method works fine, but can allow the value of the Inventory to drift out of balance over time.  Damaged or lost products, items in transit, and change in product value can all contribute to this imbalance.  To ensure this is corrected periodically, independently value your inventory balance and compare that number to the balance on your books.  Make a quarterly adjustment to ensure you are getting the numbers in sync on a regular basis.

Inventory is a challenge for most businesses, but it is generally a large portion of the value of your business.  Make sure you take a look at it regularly to ensure your numbers are telling you the right story.

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