Managing inventory is a crucial aspect of a successful retail business. Having the right product and the right amount of that product on the shelves at the right time maximizes profits. Accountants and small business owners who are familiar with a retail inventory system can use additional methods to supplement reporting.
Basics
The retail method of inventory should be used when there is a clear relationship between the cost of products and the retail price. Note that sales are the cost of goods sold at retail price. Calculate the cost of beginning inventory plus purchases during the financial quarter. Then calculate the retail figures for the same. These figures are cost of goods available and retail amount of goods available, respectively.
Let's say your cost of goods available ends at $50,000 and your retail amount of goods available finishes at $100,000. Your cost-to-retail ratio is then $50,000 divided by $100,000, or 50 percent.
Now enter the total dollars in sales at retail price. For our example, we will say the figure is $80,000. Subtract the sales at retail price from retail amount of goods available to get your estimated ending inventory at retail. Finally, multiply the estimated ending inventory at retail by the previously calculated cost-to-retail ratio to get your estimated inventory at cost. In our example, that would be $100,000 minus $80,000 equals $20,000. Multiplying $20,000 by 50 percent equals $10,000 as the estimated inventory at cost.
Advanced Applications
You may have realized that the basic method of retail inventory counts do not take inflation into consideration. This is a serious flaw; only through the application of an additional accounting method will inflation be accurately calculated. Although the retail method is sometimes used in conjunction with First In, First Out (FIFO) or weighted average cost flow, the best partner system for retail inventory is called dollar value Last In, First Out, often abbreviated as $value LIFO.
First, determine and separate increases in quantities and increases in prices. Apply a price index, by noting differences in prices from both the beginning and end of a given year, then multiplying that difference by 100. Divide the ending inventory by the price index to reach an inventory at base cost for that year. For each additional year, calculate an additional price index.
Considerations
Even after being adjusted for inflation, the retail method contains several other considerations. For instance, you will want to know and keep track of employee discounts; adjustments in policy and percentage of discounts will change your basic assumptions and must be accounted for. In addition, markdowns of retail prices will specifically impact the retail cost of goods available.
