Are you a product-based business? If so, you’re likely in the habit of stocking up on things before big markets, or holidays, sometimes months in advance.  Whether it’s for a season or event, simply for your day-to-day sales, or launching a new product line, your inventory is the key to whether those sales go through or not.  There’s nothing worse than having an interested buyer but having to turn them away because you unknowingly ran out of product.

There are so many directions we can go in talking about inventory.  Today we’re going to touch the surface of several of those topics so you can get the big picture.

WHAT IS INVENTORY?

This might be obvious, but just in case…Your inventory will include all your finished, sellable products.  If it’s on your online store, in your wholesale catalog, or with you at a market then that’s your inventory.  But on top of that, we also count anything partially complete – sometimes called “work in progress (WIP) inventory”, your raw materials – aka your stashes of supplies (supplies (its ok to admit your moderate hoarding tendencies!), or packaging materials stored throughout your studio.

Each of these components goes into your total Inventory value. 

INVENTORY VS COST OF GOODS SOLD

When it comes to your financials, those inventory numbers can end up in one of two places: on your Balance Sheet, or on your Income Statement.  Click those links to read about each of those reports.

Your Balance Sheet reports your assets, liabilities, and equity – aka what you OWE and what you OWN.  Inventory is an Asset – you OWN it, and it adds value to your business.  If you’re in a cash crunch, you could have a sale and turn that inventory into cash fairly quickly.  When your products or supplies are sitting on shelves, boxes, or bins in your home or studio that’s when you call it an asset.

The second you sell that product, however, it moves off of your Balance Sheet and onto your Income Statement as Cost of Goods Sold (COGS). Why? Well, the world of accounting only wants you to count the cost of that product when you sell it.  This is a good thing, as it ensures you only pay taxes on the gross profit of your sale, not the full revenue.

For example, if you made 100 hats last year but don't sell them until this year, you don’t want to count all the expenses from those hats last year when there was no revenue; you want to count those THIS year so that you’ll pay less taxes.  If you sell $1000 in hats, you pay taxes on the sales MINUS the cost of making those hats (say $450): $1000 - $450 = $550.  Paying taxes on $550 is WAY better than paying taxes on the full $1000.

INVENTORY VALUE VS PRODUCT COST

When you’re adding things up as they’re purchased – your raw materials, packaging, and purchases – they’re generally categorized into your Inventory (Asset) account.  Whatever these cost you, that’s what is recorded.  The total of everything, at any given time, is your INVENTORY VALUE.

Your PRODUCT COST is a calculation to get your average production cost for one product – including all raw materials, packaging, labeling, etc.

CALCULATING AVERAGE PRODUCTION COST

So how do we come up with that product cost? My preferred (aka simplest) way is to determine your average cost to make an item.

STEP 1

Set a time frame for yourself - either in the past or upcoming - where you're pumping out your treasures. It doesn't have to be long - a day, week, or month - just enough to give you a good idea of what you use and the time it takes to do what you do!

STEP 2

Work your magic! But this time, record everything - what materials you use, how much of each, the time it takes you - E.V.E.R.Y.T.H.I.N.G.

STEP 3

Now put it all together. For the materials you used, how much did you pay for them? If you didn't use all of it, estimate how much (i.e. 30%) and then multiply that by the total you paid for it.

For your time, don't sell yourself short! Determine what you're going to pay yourself and multiply this by the time it took you to make your masterpieces.  If you’re having a hard time deciding on this, try to think about what it would cost to pay someone else to do this for you.  When you’re running a production empire and have to hire a team to do this work for you, how much would you pay them?  You want to ensure you’re considering these costs so that your pricing will cover the FULL production costs of your products.

STEP 4

Divide this grand total by the number of items you created during your set time frame, and voila! You have your average cost. I suggest doing this at least once or twice a year, or whenever your supply costs change.

If you have an inventory management system or a POS that tracks inventory, you can use that average production cost number to keep an active (and accurate) tally of your COGS throughout the month, quarter, or year.

YEAR-END INVENTORY

If you are one of our bookkeeping clients [click here if you want to become one!], at year-end you’ll likely have an email from me asking for your year-end inventory count and value.  Now I won’t lie, I’m likely cursed at a little when I send out those emails.  The idea of counting every bead, box, tissue paper, label, meter of string, etc. is probably a little overwhelming (and maybe obnoxious??).

This year-end ritual, however, is critical to ensuring that your balance sheet and income statement are correct.  Without that YE adjustment, you could over-report the value of your inventory on hand, or worse (IMHO), you don’t fully count your COGS and end up paying more taxes than you need to.

My advice…make it fun.  If you have staff, get their help; if it’s just you, call in some friends.  Throw on your favorite tunes, grab some indulgent snacks, a bottle of bubbly, or a fun non-alc. Beverage and get it done.  And when it’s done – clear some room in your studio, crank the music, and have yourself a dance party – HAHA!  Or head home pour yourself a hot bath and zen out in silence.  You do you!

Finally, at the beginning of this article, I talked about the stress of having to refund sales because you didn’t know that you were out of a product.  Unless you can easily look at a shelf and see what’s there/what’s not, and the sales are coming with enough of a gap that you can mark things OUT OF STOCK.  If this isn’t the case (or if you’re just not able to say on top of those “out of stock” notices), you want to look at using those inventory features in your POS (i.e. square or Shopify) and making sure they stay up to date when you do counts or restocks.  You’ll thank yourself.

Now off you go…go count!