Retailers who sell products often use the retail inventory method to calculate their ending inventory balances. This approach is predicated on the correlation between the cost of goods and their sale price. The approach should occasionally be augmented with a physical inventory count because it is not totally accurate. For the year-end financial statements, which require a high level of inventory record accuracy, its results are insufficient.
How to Calculate the Retail Inventory Method
These steps can guide you in calculating the cost of ending inventory using the retail inventory method:
- Determine the cost-to-retail percentage using the following formula (
Cost ÷ Retail price).
- Determine the cost of the commodities that are for sale using the formula (
Cost of beginning inventory + Cost of purchases).
- Determine the period's cost of sales using the following formula (
Sales × cost-to-retail percentage).
- Determine ending inventory using the formula (
Cost of goods available for sale - Cost of sales during the period).
Understanding the Retail Inventory Method
Controlling your inventory is a crucial part of running a successful business. It enables you to comprehend your sales, determine whether to place an order for more inventory, control the cost of your inventory, and determine how much of your merchandise actually reaches customers as opposed to being stolen or damaged.
The retail inventory approach should only be applied when there is a distinct correlation between the cost of purchasing goods from wholesalers and the cost of selling them to customers. The retail inventory approach, for instance, can be applied with precision if a clothing business marks up every item it sells by 100% of the wholesale price, but it can be challenging to do so if it marks up some goods by 20%, some by 35%, and others by 67%.
The retail technique of inventory valuation only provides an approximation of inventory worth because it is possible that some things in a retail establishment have been stolen, damaged, or lost. In order to support the retail technique of valuing inventory, it is crucial for retail establishments to do a physical inventory valuation on a regular basis to assure the accuracy of inventory estimations.
Disadvantages of the Retail Inventory Method
The simplicity of calculation is the main benefit of the retail inventory approach, but there are also some disadvantages.
- The retail inventory approach is merely a guess. A physical inventory count will always win out over results.
- The retail inventory approach only functions if the markup is constant across all sold goods.
- The approach presupposes that the markup percentage's historical foundation will last throughout the current time frame. The calculations' conclusions would be incorrect if the markup had been different (as would have been the case with an after-holiday sale).
- If an acquisition has been made and the acquiree is holding a sizable volume of inventory at a markup percentage that differs materially from that of the acquirer, the approach is inapplicable.
- Retail inventory is a word used to describe an accounting method used to estimate the value of a store's inventory.
- The retail technique determines a store's ending inventory balance by comparing the cost of inventory to the cost of the goods.
- The retail inventory approach incorporates the cost-to-retail ratio along with sales and inventory for a time period.
- The retail technique of inventory valuation only provides an approximation of inventory worth because it is possible that some things in a retail establishment have been stolen, damaged, or lost.
- The retail inventory approach should always be backed up with regular actual inventory counts because it is merely an estimate.