Are you struggling to keep track of stock, frequently running out of popular items, and overstocking products that just don't sell?
Managing inventory can be an overwhelming task for any retailer. But what if there was a systematic approach to simplify it?
Enter the retail inventory method. This tried-and-true technique helps businesses estimate their ending inventory value and cost of goods sold (COGS), ensuring accuracy without having to manually count every item.
In this article, we cover the fundamentals of the retail inventory method.
What is the retail inventory method?
The retail inventory method is a way for store owners to estimate the value of their stock and COGS without having to count everything physically. This method works by comparing the costs of the items bought with their retail prices to find a cost-to-retail ratio. This ratio is then used to estimate the value of the remaining stock based on its retail price.
Because the retail inventory method can quickly and efficiently provide estimates of inventory value on a regular basis, it’s an ideal technique for big retailers with lots of inventory. It helps businesses keep accurate inventory records, manage stock levels well, and make smart buying decisions.
By providing a balance between accuracy and efficiency, the retail inventory method is a great tool for retailers looking to improve their inventory management.
How to calculate the retail inventory method
The retail inventory method is relatively straightforward. Here’s how to use it to estimate your ending inventory and COGS.
1. Calculate the cost-to-retail ratio by dividing the total cost of goods by their total retail value.
2. Determine the ending inventory at retail. Subtract the total sales from the total retail value of all the items you have for sale.
Formula:
Ending inventory at retail = retail value of goods available for sale - sales
3. Estimate the ending inventory at cost by multiplying the ending inventory at retail by the cost-to-retail ratio.
Formula:
Ending inventory at cost = ending inventory at retail x cost - to - retail ratio
4. Calculate COGS. Subtract the ending inventory at cost from the total cost of goods.
Formula:
COGS = total cost of goods - ending inventory at cost
Example calculation using the retail inventory method
Let’s consider how a hypothetical company, "Retail Fashion Co.," would use the retail inventory method.
1. First, they’d determine the cost of goods available for sale:
Beginning inventory at cost + purchases at cost = $100,000 + $200,000 = $300,000
2. Next, they’d calculate the retail value of those goods:
Beginning inventory at retail + purchases at retail= $150,000 + $400,000 = $550,000
3. Using these figures, they’d then calculate the cost-to-retail ratio:
4. They’d work out the ending inventory at retail by subtracting their total sales from the total selling price of all the items they have for sale.
Sales - ending inventory at retail = $550,000 + $320,000 = $230,000
5. They’d estimate the ending inventory at cost by multiplying the ending inventory at retail by the cost-to-retail ratio.
Ending inventory at cost= $230,000 x 0.545 = $125,350
6. Finally, they’d subtract the ending inventory at cost from the total cost of goods to calculate COGS.
Total cost of goods - ending inventory at cost = $300,000 - $125,350 = $174,650
By using the retail inventory method, Retail Fashion Co. can estimate that their ending inventory is valued at $125,350, and their COGS for the period is $174,650. The retail inventory method helps them keep track of their inventory efficiently without needing to conduct a full physical count.
The advantages and disadvantages of the retail inventory method
The retail inventory method has several pros and cons, making it better for some retail businesses than others. Understanding these can help you decide if this method is right for your inventory management.
Advantages
Here are a few of the pros when it comes to the retail inventory method:
Faster than physical inventory
Since the retail inventory method relies on estimates rather than actual counts, retailers can determine their inventory levels quickly. This is especially beneficial for large retailers with extensive inventories, where physical counting would be time-consuming and labor-intensive.
Cost-effective
Because it reduces the need for frequent physical counts, the retail inventory method can save businesses money. The time and labor needed for physical inventory counts can be used in other parts of the company, optimizing operational efficiency.
Simplifies the accounting process
The retail inventory method simplifies the accounting process, making it easier for businesses to prepare financial statements and interim reports. It provides quick estimates of inventory values and COGS, both of which are essential for accurate financial reporting and decision-making.
Disadvantages
Despite its perks, the retail inventory method has a few downsides. For example:
Doesn’t account for shrinkage
The retail inventory method doesn’t account for inventory losses due to theft, damage, or other causes. Since it relies on sales and cost data, any discrepancies caused by shrinkage aren’t reflected, which could lead to an overestimation of inventory.
Requires consistent markup
For the retail inventory method to be effective, businesses must maintain consistent markup across their products. Variations in markup percentages can skew the cost-to-retail ratio, leading to inaccurate estimates. Retailers with diverse product lines and varying markups may struggle to apply the retail inventory method correctly.
Can be inaccurate
Since the retail inventory method relies on estimates rather than actual counts, there is always a risk of error. Changes in pricing, discounts, theft, and loss can affect the accuracy of the cost-to-retail ratio, potentially causing inaccurate inventory valuations.
Alternatives to the retail inventory method
If the retail inventory method isn't suitable for your business, there are other inventory valuation methods you can consider, such as FIFO and LIFO. Let’s take a look at each of these.
FIFO Method
According to the First-In, First-Out (FIFO) method, the oldest inventory items are sold first. FIFO is particularly useful for businesses with perishable goods or products with expiration dates, as it ensures that older stock is used up before newer stock.
FIFO provides a more accurate reflection of the actual flow of goods and often results in a lower cost of goods sold during times of rising prices since older, cheaper inventory is used first. This can lead to higher profits.
LIFO Method
The Last-In, First-Out (LIFO) method assumes that the most recently acquired inventory is sold first. This method is helpful during inflation because it uses recent higher costs to calculate revenue, which can lower taxable income.
However, LIFO can leave older inventory on the records for a long time, which may not match the actual flow of goods. This method is less popular globally because it can distort financial results and is regulated strictly in some areas.
How Lark can simplify the inventory management process and much more
Lark offers a comprehensive suite of tools designed to streamline and enhance your inventory management strategy, making it an ideal choice for businesses looking to improve their efficiency and accuracy. Its many features include the following:
Seamless inventory management
Lark Base provides a flexible, database-like environment where you can manage your inventory effectively. By using Lark's pre-made templates, like the Inventory Template, you can easily input and track individual item details like ID, description, category, quantity in stock, unit price, inventory value, reorder level, and supplier information.
Lark Docs complements this by allowing you to document and share inventory-related information seamlessly with your team. You can create detailed inventory reports, share them in real time, and ensure that all the right team members have access to up-to-date inventory data.
Ready-made inventory templates
Lark offers intuitive, customizable templates specifically designed to simplify inventory management. These templates cover everything from basic inventory tracking to more complex order and inventory management systems.
For example, the Order & Inventory Management Template enables you to manage stock levels, record new items using scannable barcodes, and receive real-time restock reminders.
Inventory tasks automation
One of Lark's standout features is its ability to automate routine tasks. With Lark Base, you can assign inventory-taking tasks to employees and automate these processes.
For instance, you can set up workflows to automatically update inventory records when new stock arrives or current items are sold. This automation reduces manual effort, minimizes errors, and ensures that your inventory data is always current.
And so much more
Beyond inventory management, Lark supports other important retail operations, from employee scheduling and task management to internal communication. Its project management features allow you to keep track of multiple tasks and deadlines, ensuring that your team stays organized and productive.
Plus, with Lark’s integrated communication tools like Messenger and Meetings, you can facilitate seamless coordination among your team members.
Master your retail inventory method with Lark
The retail inventory method works well on its own, but it becomes even more effective with the right tools.
Lark makes managing inventory over time easier and boosts overall retail business operations with its powerful automation and easy-to-use templates. Whether you’re looking to improve your current inventory accuracy or streamline your retail processes, Lark has just the tools you need to succeed.
Get in touch with our team to learn more about how Lark can enhance your retail inventory method and improve your store’s efficiency.
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