Digit Lime Blog

If you sell products, you have to adjust for inventory

👕

3 minute read | Published May 30, 2023

If your business sells products and you aren't adjusting for inventory, your financial statements are incorrect. Not only is Cost of Goods Sold wrong but you will also have over/understated asset balances.

Why? Lets look at an example:

Imagine you own a T-shirt shop. Your T-shirts sell for $60 each and cost you $20 to make, so you profit $40 on each sale. This means your COGS is around 33%.

Last month (April 2023), you sold 50 T-shirts, which equates to $3,000 in sales. Since you know it costs you $20 per T-shirt, you expect your total COGS to be $1,000 (50 x $20 = $1,000).

$3,000 sales - $1,000 COGS = $2,000 gross profit

But when you're doing your financial statements you come up with the following:

$3,000 sales - $4,000 COGS = $1,000 gross loss

*minor panic attack*

"I lost money? How?"

Luckily, you didn't actually lose money. You just forgot to adjust for inventory. During the month of April, you purchased $4,000 of inventory that you put directly into COGS instead of putting it into inventory.

The KEY here is the inventory that isn't sold yet should be on the balance sheet under an asset account. Then when the inventory is actually SOLD, it's moved to COGS.

Confused? Don't worry, it's not as hard as it seems - and if you know how to apply the formula, your COGS will be correct.

To calculate true COGS, here is the formula:

Beginning Inventory + inventory purchases - ending inventory = COGS

In the table above, you can see how there was $4,000 of purchases in both examples, but when you take into account that there's still inventory on-hand at the end of the month, you get your correct COGS.

Still confused? Don't worry, these accounting concepts can take some time to fully sink in. If you'd like to focus on running your business instead of worrying about accounting concepts, Digit Lime is here for you. 😊

CHECK OUR PRICES💰

Get started in minutes. Cancel any time.