Summary: The retail inventory method is one of the most common ways to calculate the value of your stock.
Inventory is the bread and butter of any retailer, which is why you likely have a lot of your capital tied to your stock.
What this is mind, it only makes sense to keep a pulse of the value of your inventory so you can make the right decisions when it comes to what to order, what to invest in, and when to carry more products.
While there are many ways to determine and track the value of your stock, the retail inventory method is one of the most commonly used techniques out there.
In this post, we’ll give you an overview of what the retail inventory method is all about and how you can use it in your biz.
What is the retail inventory method?
The retail inventory method is an accounting technique that lets you quickly estimate the value of your ending inventory over a given time period.
You can calculate it by taking the following steps:
Step 1. Find your cost-to-retail ratio, by dividing your cost by the retail price
Cost-to-retail ratio = cost / retail price x 100
Step 2. Determine the cost of goods available for sale. You can do this by adding your beginning inventory cost to your cost of purchases.
Cost of goods available for sale = beginning inventory cost + cost of purchases
Step 3. Find your cost of sales by tallying your sales then multiply it by your cost-to-retail percentage
Cost of sales = sales x cost-to-retail percentage
Step 4. Determine your ending inventory by subtracting the cost of sales from cost of goods available for sale.
Ending inventory = cost of goods available for sale – cost of sales
Here’s an example of how the retail inventory method can work for you:
Let’s say it costs you $40 to purchase inventory, which you can sell for $100. Your cost-to-retail ratio is 40%.
Now let’s say you stock 100 units of $40 products, which puts your beginning inventory at $4,000, you then paid an additional $2,000 for purchases. This brings your cost of goods available for sale to $6,000.
From there, you generate $5,000 in sales. Multiplying that amount by your cost-to-retail ratio of 40% gives you $2,000 — which is your cost of sales.
Finally, you take your cost of goods available for sales [$6,000] and deduct your cost of sales [$2,000], and you’re left with an ending inventory of $4,000.
Are you a Vend user? You can find most of the information above — including inventory cost, closing inventory, and retail value — by running an Inventory Summary report.
Advantages and disadvantages of the retail inventory method
The main advantage of the retail inventory method lies in its simplicity. It’s a quick calculation that can give you an estimate of how much inventory you have. This can then inform your decisions when it comes to purchasing and budgeting.
That said, you need to remember that the retail inventory method only provides an estimate, and isn’t always an accurate representation of how much stock you truly have.
What’s more, the retail inventory method does not work well for merchants that don’t have a consistent cost-to-retail ratio. If your profit margins vary from one product to another, then this technique won’t give you an accurate inventory value.
Who should use this technique?
So, who are the merchants that should use the retail inventory method? Consider the following.
The retail inventory method lends itself well to multi-store retailers that need a quick snapshot of their stock. If you’re running several locations, it can be difficult to coordinate stock counts and calculations across various stores.
If you need to quickly estimate how much inventory you’re carrying, then the retail inventory method could be a good way to go.
Retailers that keep stock in warehouses
This technique also works well for merchants that want to know how much they’re stocking in their warehouses. Unlike retail stores, where the cost-to-retail-ratio is more volatile (due to sales/price cuts), the cost of products stocked in warehouses are relatively consistent, so the formula for the retail inventory method will yield more accurate results.
Retailers with consistent markups
Again, the retail inventory method works best for businesses that sell products that have a consistent cost-to-retail ratio. This means that your markups across your products should be fairly similar.
If you’re a specialty retailer that purchases products at a similar cost has adds the same markup for all or most of your products, then the retail inventory method is a good calculation to run.
On the other hand, if you sell a variety of products across multiple categories, and those items have very different markups, you likely won’t benefit too much from this technique.
When to implement the retail inventory method
The timing for when to run this calculation depends on your schedule for purchasing, accounting, etc. You may consider doing it every quarter, every year, or whenever you see fit.
However, we don’t recommend running this calculation during seasons when your markups are volatile. If you’re running sales for certain products, for example, then your cost-to-retail ratio won’t be consistent across your catalog, and the formula won’t give you an accurate view of your inventory.
Additional retail inventory method tips
Planning to use the retail inventory method in your business? Keep the following tips in mind.
Always have the right data at your fingertips
As you may have gathered, the retail inventory method requires you to pull certain numbers — including your cost-to-retail ratio, beginning inventory, sales, etc. To ensure that the calculation works for you, you need to have the most accurate numbers on hand. So equip your business with a POS and retail management system that has strong reporting and analytics capabilities.
Ideally, your software should be able to produce real-time data and can run the numbers at the drop of a hat.
If you’re a multi-store retailer, your solution should have the ability to surface your data at both a macro and micro level. So whether you need to determine the inventory values for one location or need to do it for a group of stores, your stock management system should help you do it.
Vend makes multi-store inventory management a breeze. Manage your catalog centrally in Vend, transfer merchandise from one location to the next, and use mobile stock-taking to reconcile your inventory.
Don’t abandon physical inventory counts
We’ve said it before, and we’ll say it again: the retail inventory method is simply an estimate of your ending inventory value. It’s not a substitute for physically counting and reconciling inventory.
As such, make it a point to schedule physical inventory counts. A full inventory count will likely require you to close your store or to count products before/after business hours. If this isn’t feasible, then opt for cycle counting instead.
Cycle counting is the process of partially counting products on a continuous basis, rather than doing it all on one go. When you cycle count, you typically pick a group of products to count daily until you work through your entire catalog.
Use it as part of your overall stock management strategy
Finally, recognize that the retail inventory method is a technique that should be used as part of a larger inventory management and retail success strategy. It’s a useful method, but it’s not perfect and has its limitations.
To that end, if you’re using the retail inventory method, know that it will work best when used in conjunction with practices like:
- Using tools like a modern retail management system and a barcode scanner app for easy stock reconciliation
- Keeping a close eye on your sales, stock, and inventory performance
- Conducting physical inventory counts on a regular basis
Use Vend to keep your inventory in check
Vend inventory management software enables you to streamline all your stock management processes and needs. It’s quick and easy to add and manage your products with Vend. Plus, our comprehensive reporting lets you monitor what’s selling and what’s not, so you can forecast trends, make informed buying decisions and keep your stores stocked with products that sell.
About Francesca Nicasio
Francesca Nicasio is Vend’s Retail Expert and Content Strategist. She writes about trends, tips, and other cool things that enable retailers to increase sales, serve customers better, and be more awesome overall. She’s also the author of Retail Survival of the Fittest, a free eBook to help retailers future-proof their stores. Connect with her on LinkedIn, Twitter, or Google+.