— March 14, 2019
There are dozens of ways to improve your inventory management. In this article, we have five important tips for establishing you beginning of year inventory so that you can report your taxes correctly.
The Internal Revenue Service requires you to value your inventory at year’s end so that you can determine your cost of goods sold, or COGSs, gross profits and taxable income. The IRS assumes your beginning inventory for one year is equal to the ending inventory of the previous year — if it isn’t, you must tell the IRS why. To prepare your tax returns, you need to establish your year-end inventory value, either by taking physical counts or by using an estimation method approved by the IRS.
Tip 1 – Prepare for Inventory Count
If you establish your inventory value through a physical count, your preparations depend on how you keep inventory records. If you use an automated inventory management system, you can quickly switch from normal operations to inventory counting in the waning days of the year. Paper-based inventory systems are inherently slower and require you to have stationary inventory before beginning to count. You might need to freeze paperwork, receiving, manufacturing, purchasing and shipping several days before year-end to ensure that no inventory moves into or out of your storage area during the count.
Tip 2 – Count Your Inventory Efficiently
If your inventory is small, counting by hand might suffice. However, many companies use devices such as barcode readers and radio frequency identification, or RFID, tags to speed the process. RFID readers count inventory by receiving electronic transmissions — they do not require line-of-sight access to inventory. Even if you maintain a perpetual inventory system, you can still choose to take a year-end count. This allows you to adjust your inventory value to match the information you collect, and helps detect shrinkage, damage and other problems. The IRS requires you to take a physical inventory at “reasonable” intervals to ensure accuracy.
Tip 3 – Use the Perpetual Inventory Method
The IRS allows you to use avoid year-end counting in two ways — perpetual inventory and the retail method. A perpetual inventory system immediately captures the receipt, movement and sale of inventory, relying on inventory tracking technology and an automated inventory management system. The IRS requires your perpetual inventory system to record the actual cost of inventory you buy, produce, use, transfer or sell. Your ending inventory must also reflect the value of beginning inventory.
Tip 4 – Consider the Retail Method
The IRS permits you to estimate ending inventory, and thus next year’s beginning inventory, via the retail method. To apply the method, you must calculate a cost-to-price ratio for goods you sell. You apply this ratio to sales revenue to determine your COGS. Subtract COGS from the sum of beginning inventory and the cost inventory acquired during the year. The result is your ending inventory cost. If you sell different classes of goods — the normal situation for many retail stores — you should calculate a cost-to-price ratio for each separate class and track acquisitions and sales by class.
Tip 5 – Expand Your Inventory
If you want to grow your company, try expanding your inventory through a business loan. This will allow you to purchase more inventory and more storage space in support of expanded sales. If you can efficiently manage an inventory of X size, the jump to 1.5X or 2X should not present insurmountable problems, and in return you can expand your sales revenues without a proportional increase in operational costs, due to economies of scale.