Retail Inventory Method: A How-To Guide

When you run a store, it’s critical to keep a finger on the pulse of your business. Paying attention to metrics like inventory value can reveal a lot about the state of your company’s finances and its operational efficiency.

Although knowledge is power, counting and managing inventory can be a restrictively time-consuming task. In order to quickly ascertain how much your inventory is worth, you either need a retail inventory management system that keeps track of your stock in real time, or a shortcut for manually gauging your inventory’s value. The retail inventory method was created to help you achieve the latter.

In this guide to the retail inventory method, you’ll learn: 

• What the retail inventory method is
• Why you should use the retail method for appraising inventory
• How to calculate inventory value using the retail inventory method
• Alternatives to the retail inventory method

What is the retail inventory method?

The retail inventory method is an accounting strategy for approximating the ending value of your store’s inventory, i.e., the value of the inventory remaining at the end of your accounting period. This method estimates value by comparing how much you, the retailer, paid for the products to how much you sell the products for. 

The retail method serves as a shortcut to conducting a manual inventory count, but should not replace it. After all, this method isn’t always accurate because losing or damaging a fraction of your stock is unavoidable. 

For best results, use the retail inventory method only when the products you’re appraising have the same markup. For example, this method won’t work if you’re calculating the value of jeans that have a 50% markup and pencils that have a 150% markup. Instead, compare apples to apples.  

Why you should use the retail inventory method

The retail inventory method is a helpful strategy for valuing inventory for a number of reasons.

First, it’s a faster alternative to conducting physical inventory counts. Counting inventory manually is easy when you sell large, big ticket items, like mattresses or boats. However, it’s more complicated when you run a store with many SKUs, like a boutique or grocery store, for example. This inventory accounting method is a shortcut to estimating your stock’s value.

The retail method can also help you understand when to replenish your stock. As the value of your inventory decreases, you’ll know that you’re getting closer to your reorder point. 

By using the retail inventory method, you can also gain a better understanding of how to manage inventory costs. When you know how much your inventory is worth, you gain insights into inventory-related expenses, such as holding, ordering, and shipping costs. The more you know about your business, the better you’re equipped to make decisions. 

Finally, this accounting method reveals insights into sales performance. By calculating inventory value on a regular basis, you can understand how quickly you’re selling products and see how your sales compare to those of previous months. If sales of certain items are stagnant, that could be a sign that you need to better manage overstock inventory or conduct an inventory cleanup. 

How to calculate value using the retail inventory method

The retail inventory method estimates ending inventory value. The formula for ending inventory value using the retail inventory method is:

Value of Ending Inventory = Cost of Goods Available for Sale – (Sales*Cost-to-Retail Percentage)

Let’s break down that formula further. 

Cost of goods available for sale is the cost of goods sold (COGS) for the inventory you already had in stock at the start of the accounting period plus the cost of any new inventory purchased during the accounting period. Remember to use the wholesale price you paid for the inventory, and not the price you’re charging your customers.

Cost of Goods Available for Sale = Value of Existing Inventory + Value of Newly Purchased Inventory

By sales we mean the retail value (i.e., price to customers with a markup) of the products you sold during this time.

To find your cost-to-retail percentage, a.k.a. the cost complement percentage, divide the cost of goods sold (how much you paid for the inventory) by the retail prices of those goods (how much you charge customers for those goods). Then, multiple that number by 100 to end up with a percentage.

Cost-to-Retail Percentage = (Cost of Goods Sold/Retail Price)*100

Example of calculating inventory value through the retail method

Now let’s practice putting the retail inventory method into practice. Let’s say that you run a clothing boutique and want to know the ending value of your jeans inventory at the end of the first quarter of the year. 

1. Calculate cost of goods available for sale

First you need to find the cost of goods for the jeans available for sale that you had in stock at the start of the quarter. By looking at data from your point-of-sale (POS) system, you see that on January 1, you already had $1,000 worth of jeans in stock. That makes the value of your existing inventory $1,000. 

Now you need to calculate how much you spent buying additional inventory during Q1. According to inventory reports, in January, you purchased an additional $500 in jeans, then spent $250 on jeans in February, and another $500 on jeans in March. By adding these purchases together, you learn that the value of your newly purchased inventory is $1,250.

Now we plug those figures into the formula for the cost of goods available for sale.

Cost of Goods Available for Sale = Value of Existing Inventory + Value of Newly Purchased Inventory

Cost of Goods Available for Sale = $1,000 + [$500 + $250 + $500] = $1,000 + $1,250 = $2,250

Your cost of goods available for sale is $2,250.

2. Calculate sales 

Next, you need to find out how much revenue your store generated from selling jeans during Q1. According to your retail POS reports, your boutique sold $2,500 worth of jeans from January through March.

3. Calculate cost-to-retail percentage

Now it’s time to calculate your cost-to-retail percentage, which can be found by dividing the cost of goods sold by retail price. Based on your POS reports, the average cost of goods sold for a pair of jeans in your store is $20. These retail analytics reports also inform you that the average retail price at which you sell jeans at your shop is $80.

Therefore, your cost complement percentage is:

Cost-to-Retail Percentage = (Cost of Goods Sold/Retail Price)*100 = $20/$80 = 0.25*100 = 25%

4. Input figures into inventory value formula

Now you have all the figures you need to calculate the value of your inventory at the end of Q1.

Cost of Goods Available for Sale = $2,250

Sales = $2,500

Cost Complement Percentage = 0.25

Let’s plug all of the figures into the formula:

Value of Ending Inventory = Cost of Goods Available for Sale – (Sales*Cost-to-Retail Percentage)

Value of Ending Inventory = $2,250 – ($2,500*25%) = $2,250 – $625 = $1,625

The approximate value of the inventory you have left at the end of Q1 is $1,625. 

Alternatives to the retail inventory method

The retail method to inventory represents just one strategy for calculating your inventory’s value. Alternate approaches include counting inventory, the FIFO (first in, first out) method, the LIFO (last in, first out) method, and the weighted average cost method. Let’s take a closer look at these alternatives to the retail inventory method.

Counting inventory

As noted, the retail inventory method only provides an approximate value for your inventory. It doesn’t account for items that can’t be sold because they’ve been lost, stolen, or damaged, so your actual inventory value will probably be less than this estimated value. 

The most accurate way to find out how much your inventory is worth is to do a manual count. While the retail method to inventory valuation is a good shortcut when you’re in a pinch, it can’t replace physical inventory counting.

FIFO

The First In, First Out (FIFO) method calculates the value of your inventory based on the COGS of the oldest items in your inventory. Because prices fluctuate in times of economic volatility, it can be advantageous to use an accounting method that acknowledges these changes.

The FIFO method for calculating inventory value involves dividing the COGS for the items that were purchased first by the number of units purchased. Note that this method gives you the average price for one unit of inventory, while the retail inventory method gives you the value of your entire inventory, or the segment of your inventory that you’re looking into.

LIFO

In the Last In, First Out (LIFO) method, inventory is calculated based on COGS for the newest items in your inventory. The formula for inventory value using the LIFO method involves dividing the COGS for items purchased last by the number of units purchased. As with the FIFO method, the LIFO method calculates an average cost per unit.

Weighted average cost method

The weighted average cost (WAC) method uses the weighted average cost of items in inventory to calculate their value. That means that unlike LIFO and FIFO, this method isn’t concerned with when the items were purchased. To find inventory value per the WAC method, simply divide your average COGS by the number of units in your inventory.

Retail inventory management system

When you equip your store with a retail inventory management system, you can skip counting and calculating altogether. When your POS has comprehensive inventory features built in, you’ll always know exactly how much your inventory is worth, in real time. 

Calculating inventory value through the retail inventory method

Knowing how much your inventory is worth gives you valuable information about your business. With this insight, you can understand sales performance, better manage costs, know when to reorder inventory, and more. Although the retail inventory method doesn’t replace physical inventory counts, it provides a quick estimate that can help power business decisions.

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