Keeping a close watch on your inventory ensures you always know the fastest- and slowest-moving products you have in stock. This is important because it helps you know when to reorder popular items and when you might need to discount slow-movers to make room for more profitable inventory. An even more vital factor in understanding your inventory comes down to knowing the value of in-stock merchandise, which helps you determine how much to mark each item up to meet your profit goals. The retail method of inventory management offers a straightforward way to calculate this value.
What is the Retail Method?
The retail method of inventory management is an accounting procedure that estimates the total value of in-stock products. Using this method, you add your inventory costs, including freight and other expenses, then subtract total sales from the sum. You then multiply that amount with your cost-to-retail ratio, or the percentage you marked up your products after purchase. To determine your cost-to-retail ratio, add beginning inventory costs to new inventory costs. You then divide the sum of the costs by the total of beginning inventory value and new inventory value.
The Retail Method in Action
The retail method comes in handy when you stock online or brick-and-mortar shops with clothing or other tangible merchandise. Let’s say you own a retail clothing shop with $9,000 worth of merchandise in stock, then you add another $1,000 when you purchase 100 shirts from a wholesaler. If you mark each item in your shop up 100%, it gives your $10,000 inventory a retail value of $20,000. When you have sales of $10,000 and wish to know how much to reorder to fill your shelves, you can use the retail method to estimate your current inventory. Take the total value of the stock, or $20,000, then subtract the $10,000 in sales, which equals $10,000. Now divide the original $10,000 inventory cost by current $10,000 value to get an even ratio of one. When you multiply your ending inventory total of $10,000 by one, you see that your current inventory has a $10,000 value.
Advantage and Disadvantages of the Retail Method
The retail method of inventory management saves you time by eliminating the need to take physical inventory when you want to know the value of your stock. Using this method, you only need to record the retail prices and some simple math. This makes the retail method great when you need to create a business budget or prepare financial statements to use when seeking investors or filing paperwork. Complications arise when you mark down prices for sales and other special events, requiring additional subtraction to calculate accurate totals. Also, the retail method fails to take damaged items or shrinkage into account, leaving you with approximations rather than precise totals. When you need a quick and easy way to calculate the value of your inventory, the retail method comes in handy. By knowing the approximate value of the products you have in your warehouse or storeroom, you can better gauge sales performance and know when you need to reorder items or seek out new product lines.