The end of the calendar year signals fun and festivities, but if you are a business owner with physical products, it should also be a signal to take your end of year inventory! With New Year's Eve parties on the mind, it can be easy to forget to count how much inventory you have on hand at the end of the year for tax purposes. Don't fear! Counting your end of year inventory does not have to be complicated. Let me walk you through the basics of what you need to know to get the job done fast!
Only business owners who sell a physical product need to worry about taking inventory. If you are a blogger you can breathe a sigh of relief, you don't need to worry about counting your pencils and paperclips!
If your tax year ends on December 31st (most do) your inventory count needs to be of the product and materials you have on hand at that date.
So what do you count?
Merchandise and stock on hand. These are products that you purchase for resale. For instance, we sell “Be Brilliant” mugs in our Brilliant Business Moms store. We designed these mugs and purchase them from another vendor for resale in our store. We will count how many mugs we have on hand at the end of the year.
Raw Materials. Many handmade sellers combine raw materials to make their products. As an example, if you are a handmade purse seller, your raw materials might include fabric, zippers, and ribbons.
Work in Process. Work in process items are items that are only partially completed. Back to our handmade purse example, if you have 10 purses sitting in your shop that are partially complete, count the materials included in the partially completed purses.
Finished Products. Count the number of 100% completed purses separately from the purses that are still in process. The inventory value of finished products is the sum of the cost of the raw materials that comprise it.
Supplies that Physically Become Part of the Finished Product. These are smaller items that eventually become part of the physical item you sell. In our example thread, snaps, and other small items would fit in this category. Do not include supplies that will not become part of your finished product such as tools or office supplies.
If you have sold an item, but have not shipped it, DO NOT count this item in your inventory. If you have ordered materials and paid for them, but they just haven't arrived yet, DO count those in your inventory.
For certain items it can be difficult to determine exactly how much you have on hand, but a little creative thinking may help you arrive at a fast answer. For instance, lets say you bought two gigantic spools of silk ribbon this year, you've used part of one, but the other is untouched. Weigh the untouched spool, and then weigh the partially used spool. The difference in weight will give you a good estimate of how much was used.
When all else fails, make a good estimate.
How do you value your inventory?
There are many different methods that business owners can choose to value their inventory, but the simplest and most widely used method for small business owners is the Cost method. With the Cost method, you value your inventory at the price you paid for it. The IRS considers the cost to be your invoice cost, including any discounts and transportation. So if you bought 100 yards of fabric from your fabric wholesaler, and the price was $5 per yard, shipping was $50, and you used a $25 off coupon, your total invoice price paid was $525 or $5.25 per yard. If you have 8 yards on hand at the end of the year, then your inventory value is $42.
The IRS loves record keeping, so I find that the easiest way to calculate your inventory each year is to create a simple spreadsheet with your item in the first column, the quantity in the second column, the cost per item in the third column, and then calculate the inventory value in the fourth column. Each year you can create a new sheet in your inventory spreadsheet, copy over the previous year, and then adjust as necessary. Many times some values from the previous year will remain the same which will save you some time and effort.
Where will you need this information on your tax return?
You will need to know your ending inventory value for Schedule C Line 41 as part of the calculation for Cost of Goods Sold. Your beginning inventory number will be last years ending inventory, or if you are brand new to business, your beginning inventory will be zero.
What if you are late counting your inventory?
Sometimes circumstances don't allow you to count your inventory on December 31st. In that case, count your inventory a few days before or a few days after December 31st and adjust your numbers. For instance if you count your inventory on December 28th, and then sell 10 mugs during the next few days, just reduce your inventory count by 10 to reflect how many mugs you had on hand on December 31st. Conversely if you forget to count until January 4th, take a look at your sales from the 1st-4th and add those products back into your inventory on hand as of December 31st.
Don't be caught off guard when you go to complete your tax return. Take a little bit of time now to conduct your end of year inventory, and be prepared with solid numbers when you are in the trenches of completing your tax forms and schedules.
I am an accountant, and the information presented here was derived from the IRS website and their discussion on Inventory. Nevertheless, each tax situation is different so use your own judgment when applying this advice to your own unique situation.
P.S. Quick Tip – delay restocking your inventory until the New Year if you want to reduce the amount of items you have to count!
For more helpful tax advice, check out The Blogger's Simple Guide to Taxes: A Guide to Saving Time and Money!