Wednesday, March 25, 2009

Ahhh - Tax Time and Inventory!

Disclaimer: I do NOT know tax law or give tax advice. The article below is a summary of what I have done for the last 6 years and works with my tax accountant. You need to make sure you are doing what is necessary for your own tax purposes.

Entrepreneurs are passionate about what we do. We want to create, run our business and hopefully make some money. But one thing we don't want to do is taxes!

This time of year small business owners everywhere are saying "I just want to run my business! Someone please just figure this tax stuff out for me!"

This article is about just one of the things we have to track every year - Inventory.

I make jewelry and sell cross stitch books. I have a HUGE inventory for someone who works out of their home. Especially my beads - I literally have tens, if not hundreds of thousands of beads. What's a girl to do?

Why do I need to track my Inventory anyway?

I'm not a tax expert, and I'm not going to even begin to assume to give tax advice. Everything is different for everyone depending on your state, what type of business you are etc. But here are some basics that usually apply to all.

My inventory amounts are required for my Schedule C form which I fill out for my taxes. In addition, the inventories are used in the Cost of Goods Sold Calculation.

Here are some basic definitions:

Beginning Inventory: The total amount of inventory you had on hand at the beginning of the fiscal year.
Purchases: The amount of inventory you purchased (added to) your inventory during the entire fiscal year.
Ending Inventory: The total amount of inventory you had on hand at the end of the fiscal year.
Cost of Goods Sold: The amount of inventory you 'used up' in selling your items.

Here is the basic calculation:

Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold

Cost of Goods Sold is an expense. At tax time this is a GOOD thing - because that expense is deducted from the your gross sales. You don't want to pay taxes on your gross sales - you want to pay taxes on your gross sales less all of your expenses (net sales).

For example. I design a necklace that I sell for $50. But I didn't' actually MAKE $50 did I? If the materials in the necklace cost $15 (cost of goods sold), then I 'made' $35.

Of course there are many other expenses and considerations - this article is just concerned with inventory/COGS.

So - to simplify to the extreme - you need to know your total Cost of Goods Sold at the end of the year.

Inventory Approach #1 - Count.

At the beginning of the year count your inventory. If you make jewelry - count every bead, know what the bead cost, and add it all up. This is your beginning inventory.

During the year keep track of all purchases you make for inventory. If you make jewelry track all beads, findings, wire, etc. Everything that goes into making your designs. Do NOT count shipping, office supplies etc. Those are different types of expenses.

At the end of the year count everything again to see what you have on hand now.

Remember - if you have jewelry already made up - but not sold - that counts as inventory too! You must know the value of your loose beads in addition to the value of the beads in your "Finished Goods".

The apply the formula from above:

Beg. Inv. + Purchases - End. Inv. = Cost of Goods sold.

The good news - the next year you already know your beginning inventory - it's the ending inventory from last year!

Approach #2 - Track COGS

Here is what I do. Instead of counting my inventory at the end of every year I track my COGS throughout the year.

A couple of years ago I counted my entire inventory and determined my beginning inventory total.

I track every purchase I make.

When I store my inventory (in my case beads, books etc). I mark each item with what I paid for it. For example my beads are stored in separate containers by like type/price.

When I design a piece I calculate what it cost to make that item. I include everything, wire, crimp beads, jump rings, head pins, and of course the main components.

Then I tag that item with an inventory number and enter it into a database where I input the total cost of the design (COGS).

When the piece is sold, then I know how much I spent to make that item. At the end of every month I add up my total COGS and enter that into my books. Then at the end of the year I know how much I spent on materials without having to recount my inventory.

I use this calculation:

Beg Inv. + Purchases - COGS = Ending Inventory.

This takes a lot of organization up front - but will save you SO MUCH time and frustration at tax time.

Is it 100% accurate? No - of course not. But how accurate is it when you count 150,000 individual beads and aren't really sure if you paid .06 cents or .08 cents for any given bead? I believe the system I use, in my situation, is more accurate then trying to count.

In addition, I am much more aware of what it took to design a given piece and therefore am better at knowing what to charge for it.

Hope this article makes sense and is helpful. Please feel free to post comments/questions.

Please do NOT copy this article. If you want to refer to it - please post a link to my blog. Thank you!


Tip-Tops said...

Awesome! I had done my own blog post on Monday, but decided to just link back to yours. Yours is so much better!!


Katie Lin said...

Awesome post! It helped me alot. There is only ONE thing I am confused on, though! So for 'COST OF PURCHASES' is that that cost of all purchases made in 2008 or is it only the cost of the purchases that went in to items that actually sold? Thanks in advance :)

julie said...

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