The Retail Inventory Method, Explained

How much retail inventory do I have left this period? What is its total value? If counting by hand, performing a physical inventory count of your merchandise can be time-consuming and even expensive, as it could mean shutting down the store to get an accurate count.

Adopting the retail inventory method can help owners get a more regular sense of what’s available. By accurately setting up inventory and accounting logistics, business owners can better manage operations and continue to grow.

There are, of course, advantages and disadvantages to adopting this approach. But first, let’s get a few things clear.

What Is the Retail Inventory Method?

All the automated sales tracking in the world isn’t a substitute for actually seeing what you have on the shelves. For some, taking inventory would mean closing the store to get an accurate count. But it also means paying staff for time when no sales are being generated.

The retail inventory method offers more of an approximation.

Here’s how it works:

• Calculate the cost-to-retail percentage
• (Cost ÷ Retail price)
• Calculate the cost of goods available for sale
• (cost of beginning inventory + cost of purchases).
• Calculate the cost of sales during the period
• (Sales x cost-to-retail percentage).
• Calculate ending inventory
• (Cost of goods available for sale - cost of sales during the period).

To save you time doing manual operations, we have created a calculator. Just enter the values required for the formulas below and you'll obtain metrics for your retail inventory.  

Retail inventory method calculator

The result is the total value of the inventory on hand at the time.

Here’s an example: Kenyatta’s B Corp sells home coffee roasters for $250 retail, which cost $150. Cost-to-retail percentage is 60%. Kenyatta’s beginning inventory cost $1,100,000 and paid an additional $1,900,000 for purchases. They experienced sales of $2,500,000. The calculation of its ending inventory is:

Related blog: Comparing different inventory valuation methods: FIFO, LIFO, and WAC

Advantages and Disadvantages of the Retail Inventory Method

Using the retail inventory method saves retail operators and merchants the time and expense of shutting down for a period of time to conduct a physical inventory.

It’s part of the Generally Accepted Accounting Principles provided by the American Institute of CPAs. And this method creates a report on the value of the inventory on hand, a useful document when it comes to determining the value of a business.

While the upside of adopting the retail inventory method for your business are real and substantial, there are some potential drawbacks commerce retailers and merchants should be aware of.

• This is just an estimate and doesn’t account for items that are broken, stolen or otherwise taken out of inventory for reasons other than a sale (e.g. natural disaster).
• It works best when the markup is consistent across products. If different items feature different markups the end result won’t be completely accurate. 
• Large additions of inventory, such as would happen in the event of acquiring another company, throw off the calculations.

These aren’t reasons to not use the retail inventory method, but are points that should be considered prior to implementation.

Related blog: Advanced inventory and order management with B2BGateway's EDI solution

Who Should Adopt the Retail Inventory Method?

The retail inventory method is not a system that will work best for everyone. Those will find the most value in it tend to be:

• Retailers with multiple locations, since physical inventories can be difficult to coordinate for the same time in different places.
• Those who don’t often have large amounts of goods in transit or otherwise in flux since it doesn’t account for those.
• Those who are comfortable with estimates that are available on a more regular and on-demand basis.

Even if the retail inventory method is found to be a good fit for your business, a physical inventory that stops the clock and actually counts the goods on hand is still recommended as it provides a more clear picture of sales and value.

Related resource: Guide - What is inventory Management? Know the basics

Remember: The retail inventory method is closer to being an educated guess than a concrete calculation of how much value is currently held in the form of product. It provides numbers that are directionally accurate and so can help give snapshots at any given time, even if those pictures aren’t as clear or detailed as physical inventory.