Retail Inventory Method
The retail inventory method is an accounting method used to estimate the value of a store's merchandise. It allows you to understand your sales, when to order more inventory, how to manage the cost of your inventory, as well as how much of your inventory is making it into the hands of consumers, as opposed to being stolen or broken. The retail inventory method should only be used when there is a clear relationship between the price at which merchandise is purchased from a wholesaler and the price at which it is sold to customers. The retail inventory method calculates the ending inventory value by totaling the value of goods that are available for sale, which includes beginning inventory and any new purchases of inventory. It's important for retail stores to perform a physical inventory valuation periodically to ensure the accuracy of inventory estimates as a way to support the retail method of valuing inventory. The retail method of valuing inventory only provides an approximation of inventory value since some items in a retail store will most likely have been shoplifted, broken, or misplaced.
What Is the Retail Inventory Method?
The retail inventory method is an accounting method used to estimate the value of a store's merchandise. The retail method provides the ending inventory balance for a store by measuring the cost of inventory relative to the price of the merchandise. Along with sales and inventory for a period, the retail inventory method uses the cost-to-retail ratio.
Understanding the Retail Inventory Method
Having a handle on your inventory is an important step in managing a successful business. It allows you to understand your sales, when to order more inventory, how to manage the cost of your inventory, as well as how much of your inventory is making it into the hands of consumers, as opposed to being stolen or broken.
The retail inventory method should only be used when there is a clear relationship between the price at which merchandise is purchased from a wholesaler and the price at which it is sold to customers. For example, if a clothing store marks up every item it sells by 100% of the wholesale price, it could accurately use the retail inventory method, but if it marks up some items by 20%, some by 35%, and some by 67%, it can be difficult to apply this method with accuracy.
The retail method of valuing inventory only provides an approximation of inventory value since some items in a retail store will most likely have been shoplifted, broken, or misplaced. It's important for retail stores to perform a physical inventory valuation periodically to ensure the accuracy of inventory estimates as a way to support the retail method of valuing inventory.
Calculating Ending Retail Inventory
The retail inventory method calculates the ending inventory value by totaling the value of goods that are available for sale, which includes beginning inventory and any new purchases of inventory. Total sales for the period are subtracted from goods available for sale. The difference is multiplied by the cost-to-retail ratio (or the percentage by which goods are marked up from their wholesale purchase price to their retail sales price).
The cost-to-retail ratio, also called the cost-to-retail percentage, provides how much a good's retail price is made up of costs. If, for example, an iPhone costs $300 to manufacture and it sells for $500 each, the cost-to-retail ratio is 60% (or $300/$500) * 100 to move the decimal.
Disadvantages of the Retail Inventory Method
The retail inventory method's primary advantage is the ease of calculation, but some of the drawbacks include:
Example of the Retail Inventory Method
Using our earlier example, the iPhone costs $300 to manufacture and it sells for $500. The cost-to-retail ratio is 60% ($300/$500 * 100). Let's say that the iPhone had total sales of $1,800,000 for the period.
Related terms:
Accounting
Accounting is the process of recording, summarizing, analyzing, and reporting financial transactions of a business to oversight agencies, regulators, and the IRS. read more
Acquisition
An acquisition is a corporate action in which one company purchases most or all of another company's shares to gain control of that company. read more
Average Inventory
Average inventory is a calculation that estimates the value or number of a particular good or set of goods during two or more specified time periods. read more
Cost of Goods Sold – COGS
Cost of goods sold (COGS) is defined as the direct costs attributable to the production of the goods sold in a company. read more
Days Sales of Inventory – DSI
The days sales of inventory (DSI) gives investors an idea of how long it takes a company to turn its inventory into sales. read more
Ending Inventory
Ending inventory is a common financial metric measuring the final value of goods still available for sale at the end of an accounting period. read more
Inventory :
Inventory is the term for merchandise or raw materials that a company has on hand. read more
Last In, First Out (LIFO)
Last in, first out (LIFO) is a method used to account for inventory that records the most recently produced items as sold first. read more
Net Realizable Value (NRV)
Net realizable value is the value of an asset that can be realized upon its sale, minus a reasonable estimation of the costs involved in selling it. read more
Purchase Price
The purchase price is what an investor pays for a security. It is the main component in calculating the returns achieved by the investor. read more