The retail inventory method is an inventory accounting method that estimates the value of your inventory for a specific time period.
When your business revolves around physical products, monitoring inventory levels is crucial to keep operations running smoothly. That said, physical inventory counts are one of the biggest roadblocks to scaling product-focused businesses. They’re time-consuming and cut into resources that could otherwise be spent on activities directly impacting the business.
That’s where the retail inventory method comes in: a calculation that quickly gives you an accurate picture of your inventory value at any given time—without getting lost in the details. You can use several inventory valuation methods, but the retail inventory method is one of the most efficient ways to do so each month.
This article will explain when to use the retail inventory method, how to calculate it, and the risks to be aware of.
What is the retail inventory method?
The retail inventory method (RIM) is a formula that estimates your company’s inventory value for a given time period. It’s typically done at the end of an accounting period to get an approximate idea of how much your ending inventory is worth.
The retail inventory method is relatively quick and cost-effective compared to other inventory counting methods. That said, it’s not 100% accurate and can’t fully replace cycle counts or physical counts.
How to calculate the retail inventory method
Here’s the formula to calculate ending inventory using the retail inventory method:
Ending Inventory Value = Cost of Goods Available for Sale — (Retail Sales x Cost-to-Retail Ratio)
As you can see, there are a few metrics you need to calculate before you run the RIM formula. Let’s break down each step, then walk through an example.
1. Cost of goods available for sale
This calculates the cost to obtain all of your inventory units that are ready to be sold.
Cost of goods available for sale = cost of beginning inventory + cost of inventory purchases for the period
2. Cost-to-retail ratio
This is the percentage of an inventory item’s retail price that’s made up of costs (also known as the markup percentage).
Cost-to-retail ratio = (cost of one unit / retail price of one unit) x 100
3. Retail sales
This is how much revenue you earned from total sales over a specific time period. No calculation is necessary here.
4. Ending inventory value
The retail inventory method uses the information above to calculate ending inventory: the total value of goods you have available for sale at the end of an accounting period (i.e. the end of your fiscal year).
Ending Inventory Value = Cost of Goods Available for Sale — (Retail Sales x Cost-to-Retail Ratio)
Retail inventory method example
Let’s walk through how a retail inventory method calculation would work in real-life for an ecommerce company.
- At the beginning of the current period, the company has $30,000 worth of inventory
- The company then spends 40,000 on additional inventory throughout the period
- Each inventory unit costs $50 to buy from the manufacturer, and the selling price is $100 each
- The company sells $60,000 worth of products by the end of the period
Using the information above, we can calculate the necessary elements of the retail inventory method formula.
- Cost of goods available for sale: $30,000 + $40,000 = $70,000
- Cost-to-retail ratio: ($50/$100) x 100 = 50%
- Retail sales = $60,000
- Ending inventory value = $70,000 — ($60,000 x 50%)
Ending inventory value = $40,000
What types of businesses should use the retail inventory method?
Any type of business that handles physical products can use the retail inventory method. However, there are a few types of businesses for whom the method can be especially useful:
- Multi-location retailers
- Retail businesses with consistent markups
- Retailers that don’t do sales or markdowns often
- Retailers that store inventory in warehouses
- Wholesalers carrying large volumes of similar products
Advantages and challenges of the retail inventory method
The retail inventory method comes in handy when you need a quick estimate of your inventory value, but it’s not without drawbacks. Below, we weigh the pros and cons of the retail method.
Advantages of the retail inventory method
- Streamlined inventory counts: RIM lets you evaluate your stock in a matter of hours, instead of days or weeks. The method also doesn’t require you to review purchase orders or invoices.
- Practical for most retailers: You don’t need advanced accounting expertise to use RIM; it works for businesses of all shapes and sizes.
- Requires minimal resources: RIM takes much less time than manual inventory counts or cycle counts, so your team can devote more resources to growing the business.
Alternatives to the retail inventory method
If the retail inventory method doesn’t meet your needs, here are three alternative methods to consider.
Weighted average cost
The weighted average cost method determines inventory value based on the average cost of purchased goods that are available for sale. This is often used when retailers have trouble assigning a specific cost to an individual unit.
Weighted average cost is calculated by dividing your total inventory cost by the total number of units in your inventory.
Last in, first out (LIFO)
The LIFO method calculates inventory value based on the cost of goods sold (COGS) of your most recent inventory purchases. LIFO assumes that the most recent inventory items are sold first, which are the most expensive.
First in, first out (FIFO)
The FIFO method calculates inventory value based on the COGS of your oldest inventory. FIFO assumes that the oldest items purchased are the first items sold, and older inventory items are less expensive than recent purchases.
How QuickBooks supports inventory management for retailers
Whether you sell five or 50,000 products, there’s no room for guesswork when it comes to managing your inventory. That’s why QuickBooks Enterprise offers customizable inventory management features specifically for retail businesses.
QuickBooks puts real-time inventory information at your fingertips. Instantly see what’s in stock, what’s on order, where each item is located, and what it’s all worth so you can make fast, informed decisions.
Further, you can automate repetitive processes like reordering so your team can spend less time on data entry and more time growing your business.
Final thoughts
The retail inventory method is a handy tactic for business owners to estimate the value of their stock levels. But it’s just one facet of a more robust inventory management strategy.
Along with powerful inventory management software, cycle counts, and physical counts, RIM ensures you always have an accurate picture of what your stock is worth so you can make better business decisions.
