Inventory and COGS Accounting | Free template included!

1:02 Product cost and count vocabulary

Let's talk about the process if you decide to compute your cost of goods sold yourself. First, just to make sure we're clear on some basic vocabulary, let's talk about costs. Your product's cost is how expensive it is to you, so this includes everything that it takes to get your inventory from your supplier all the way to your warehouse, ready to go to sell to your customer, to your consumer. So this could be your purchase cost for the inventory itself, the freight, tariffs, inbound shipping, packaging or labels that you add to it if you put it in a special box. All of those things are going to be part of your product cost. For the purposes of this video, I'm going to assume that you already know your cost per unit per SKU.

When I talk about your counts, I'm referring to the number of units per SKU on hand. So this number may come from any number of places. We'll talk about that a little further down the road, and it can be more or less reliable depending on where you get this number. But your count is always a quantity.

2:01 When you should not do this yourself

You likely don't want to do your computations yourself if you manufacture. So your costing process is likely to be pretty complex. You probably have different kinds of inventory that flow into one another, so you might have raw materials, finished goods, packaging and labels. Lots of different kinds of inventory. You're better off with some support to make sure that things are set up correctly if this is you.

Another reason you might want some support is if your costs fluctuate either very frequently or very widely. So it's one thing to update your costs every year or every quarter, make some small adjustments here or there, but if your costs are truly volatile, you're going to want some accounting support.

Another reason you might want some help is if there's a time delay between purchasing and receiving your inventory. So the model I'm going to show you here assumes that you walk into a store, pay for your inventory with your credit card right there, and take it back to your warehouse with you, all on one day, one instant.

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Obviously that's not how most inventory purchases work, but in the beginning that can kind of be close enough for jazz. Eventually though, the model is going to break down. So this can go in either direction. If you have credit terms that allow you to pay for your inventory months and months and months after you receive it, or more commonly you pay a deposit on your inventory up front, or have some other sort of installment arrangement, the further apart your purchase and the receipt of inventory are, the more likely you are to kind of want some support from professionals to go through this.

And last is any sort of unexplained adjustments or other weirdness. So if you know that your processes are kind of out of the box, or you keep seeing large adjustments when you don't expect them as you get into your physical inventory evaluation, or you just are a little lost, you try to put this together and it's harder than you think it's going to be, or the numbers just don't seem to add up the way you expect them to, we're happy to answer some questions. So those are some reasons that you might want to consult an expert and not try to DIY your COGS.

4:03 The quantity reconciliation sheet

All right, next I want to show you an example of a quantity reconciliation sheet. So the general equation that you're going to use here is your beginning inventory, plus your received inventory, minus your sold inventory, minus your known inventory happenings, or sometimes plus but more commonly minus, equals your ending inventory. So mathematically this should make sense. What you have, plus what you've got, minus what left, is what you end up with.

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And so let's kind of break this down and go into the details. So your beginning count is going to come from when you did this process last month.

The quantity received is likely going to come from your warehouse workers, or maybe your 3PL. Sometimes it's tricky to get this number. You can sometimes impute it from your invoices, and your delivery dates on your documentation can give you a best guess, but this is often the most difficult and least reliable number. So be aware of that. Just be kind of thoughtful about how you gather this quantity received information.

Your quantity sold will usually come from your sales channel, in the various different reporting options that you have there.

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Known inventory happenings can come from truly anywhere, usually from your warehouse or from your 3PL. In some software these are referred to as adjustments. So this can be inventory that you gave away or threw away because it was spoiled, discarded. Anywhere that things can disappear to or show up from by surprise is going to be in this column, your known inventory happenings.

And your calculated end quantity, again, this is what your ending inventory theoretically should be if math were the be all end all. So I have B2 plus C2 minus D2 plus E2 is how I've mathematically set this up, so that it matches our equation over here.

Your actual ending quantity is going to come from your physical count. So as much as possible, someone should be physically going to your warehouse and counting to see how many of each item are still there.

6:03 Investigating the differences

Any big differences between your calculated end quantity and your actual ending quantity, so here's your difference, any big differences are going to need some investigation.

So on this set of sample data I want to show you a few of those differences. These minor ones I'm not too worried about, two, three, four items at a time in either direction. It's the larger quantity discrepancies that need some more research.

So we already know about some of them. We know that 600 of these were destroyed by an ink spill. 30 of these were broken when a box was dropped. The manufacturer included extra of these because they accidentally overproduced a little bit. And then this set of SKUs we discarded because they're not good to us anymore, they were obsolete.

But these hundred units that disappeared and these 162 that showed up out of nowhere, we need to investigate the story here. So maybe here you forgot to count some of the inventory that you were storing in the bathroom. Maybe you had an employee walk away, some theft happening there. And then for your extra inventory, maybe this was just a counting error. So maybe this was typed incorrectly, maybe a receipt wasn't recorded, maybe you counted a shelf twice. I don't know the reason exactly, it could be any number of things. But when you see big differences, moral of the story is figure out the story. What happened here?

7:28 Calculating the COGS number

So once you've done that gut check on your quantity sold, finding the COGS number itself is pretty straightforward. So you're going to take that quantity sold that you identified back here on your quantity reconciliation, you're going to multiply it by the cost per SKU, remember we're assuming you already know that value here. You're going to multiply them together, add it all up, and you should end up with this total cost of goods sold value.

So this number is much more useful than the amount of cash that you spent on inventory during the period. This number is exactly what it sounds like. It is the cost of all the goods that were actually sold for the period.

8:02 Physical inventory evaluation

Now for your physical inventory evaluation, this is a process to true up and check your work. You want to do this at minimum once a year to make sure that your financial statements are reasonably accurate for tax purposes. But doing it quarterly or monthly is a good way to make sure that your statements are actually useful to you for decision making purposes, and not just to the IRS for charging your taxes.

So the math here is really similar to COGS. You're going to take your cost per SKU that you already have, you're going to multiply it by the total number of units that you have on hand right at this moment. So in this case we have two different locations, we add them together to get the total count. You multiply your cost by your total count to get your total value. We're going to add all this up, and this shows you the total value of the inventory that you have on hand.

If this is too far off from what's in your books, again you're going to ask yourself that question, what's the story here? Why doesn't this match? Some adjustments are inevitable. It's never going to be exactly what you expect it to be. But if you're getting numbers here that are wildly different from what you expect, this is when you might want to reach out for some support, especially if that happens more than once over time.

I hope this has been helpful. Good luck with your inventory and cost of goods sold, and feel free to reach out with any questions.