Generally, if you produce, purchase, or sell merchandise in your business, you must keep an inventory. This inventory, and the management of it, directly impacts the profitability of your company and is recorded on your income taxes in terms of Cost of Goods and Inventory Valuation.
Inventory Management is Critical to your Business
Many small business who sell products do not manage their inventory properly or utilize all the features in QuickBooks for doing so. This can result in over or under estimating profits, over or understated inventory values at year end and consequently over or under payment of taxes. I am going to briefly discuss some of those QuickBooks features and the most common mistakes I see in inventory management.
To understand how important inventory is to your business, you only have to perform a simple calculation: Gross sales (the revenue generated by selling your product) minus the cost to make those items you sold (Cost of Good Sold or COGS) equals Gross Profit. This basic financial formula tells you whether or not you are making money selling your product.
From the Gross Profit, you subtract all the other costs of running your business (operating expenses) and you have your Net Profit.
The cost for ALL the components that go into making your products, and any unsold products are totaled and kept in an account on your Balance Sheet called Inventory Value (or Raw Materials and Finished Products).
The inventory component in the above calculation is the Cost of Goods Sold. This is not the total cost of all the components that go into making your product – only the cost of the components for the items you sold, which is transferred from the total (Inventory Value) when you sell it.
For any of you who are not following me… the good news is that QuickBooks automatically does all of that for you IF you use QuickBooks properly.
There are two important parts in QuickBooks to set up properly: the Items & Services (or Products & Services in QBO) and your Chart of Accounts. The best QuickBooks software for handling Inventory and Assemblies is QuickBooks Premier and QuickBooks Enterprise. You can track inventory in both QuickBooks Pro and QuickBooks Online, but not Inventory Assemblies (two or more components you assemble to sell).
You need to set up an item for each component you purchase that goes into the finished product. In QuickBooks Desktop, you want to make sure that you set them up as double-sided Inventory Parts with the Purchase side pointing to the correct COGS account the the Sales side to the proper Income account.
Inventory Part in QuickBooks Desktop Versions
Inventory Part QBO
In QuickBooks Desktop, there are 12 different Item Types you can set up so it’s important to know how each one works. Inventory Parts and Inventory Assemblies are the only types that have a count associated with them.
Non Inventory Parts can be used to track inventory COGS… BUT you need to make sure to check the box to make it a “double-sided” item.
Non Inventory Parts
Important Things to Know about Inventory
- You need to physically count your inventory at least once at year at the end of your fiscal year.
- You need to account for any changes in inventory including sales, returns, damaged goods, donated items, items pulled for personal use and spoilage. There is a procedure for handling each of these in QuickBooks.
- Inventory management is the process of efficiently overseeing and recording the constant flow of units and dollars into (purchasing, assembly, stocking and returned goods) and out of (sales, invoicing, donations) existing inventory.
- QuickBooks uses Cost Averaging to determine the value of your inventory unless you purchase additional inventory modules (Premier & Enterprise).
Inventory can be easily managed in QuickBooks, including direct labor costs, landed costs and other components of your true Cost of Goods. If you are not managing your inventory properly in QuickBooks, please get training on how to do so – the result could be tax saving and profitable!