Retail Accounting Basics: Inventory, Sales Tax and Cash Flow

Set up your books for a store

Use accounting software, a separate business bank account and a chart of accounts that separates sales, cost of goods sold and operating expenses.

Start with the foundation. Open a business bank account and a business card, and connect both to your accounting software. See best bookkeeping software and opening a business bank account.

Your chart of accounts should include:

• Sales by category, such as in-store, online and wholesale
• Cost of goods sold
• Inventory as an asset
• Sales tax payable as a liability
• Payment processing fees as an expense
• Rent, payroll, utilities and marketing

Connect your point-of-sale system so daily totals flow into the books. If you need background, read accounting for small business.

Inventory and cost of goods sold

Inventory is what you hold to sell. Cost of goods sold is what you paid for the items you sold. The two together drive your gross profit.

The basic formula is: beginning inventory plus purchases minus ending inventory equals cost of goods sold. Gross profit is sales minus that cost. Walk through it in calculating cost of goods sold and inventory accounting.

Illustrative example: you start the month with $40,000 of inventory, buy $25,000 more and end with $35,000. Cost of goods sold is $30,000. If sales were $55,000, gross profit is $25,000, or about 45 percent. Methods like first-in-first-out, last-in-first-out and weighted average change how costs are assigned, so ask your accountant which method is allowed and best for you.

Sales tax and daily reconciliation

Collect the right sales tax, report it on time and reconcile your register or POS to the bank every day or week. Sales tax is not your money.

Sales tax rules vary by state and sometimes by city, product type and shipping destination. Register with your state's revenue department, collect the correct rate and file on schedule. Keep sales tax collected in a separate account if possible, so it does not get spent.

A daily routine saves headaches:

1. Print or export the end-of-day report from your POS.
2. Compare cash counted, card batches and gift card activity.
3. Record over or short amounts.
4. Match deposits to the bank statement within a few days.

For monthly checks, use the steps in bank reconciliation. For online sales across states, check each state's rules or ask a tax professional.

Shrinkage, returns and markdowns

Theft, damage, errors and returns reduce profit. Count stock regularly, track returns and markdowns, and compare book inventory with the physical count.

Retail books often show more inventory than the shelves hold. The difference is called shrinkage, caused by theft, damage, miscounts and supplier errors. Cycle counts, where you count a section each week, catch issues faster than one annual count.

Track returns and markdowns separately instead of netting them out of sales. They show which products and vendors cause problems. Review the inventory turnover ratio to see how quickly stock sells. Slow turnover ties up cash. Items that sit for months may need a markdown, bundling or return to vendor.

Reports to review every month

Review the profit and loss statement, balance sheet, cash flow statement, sales tax report and inventory report. Together they show profit, position and cash.

• Profit and loss. Sales, cost of goods sold and expenses. See the income statement.
• Balance sheet. What you own and owe, including inventory. See understanding the balance sheet.
• Cash flow statement. Where cash came from and went. See what goes on a cash flow statement.
• Sales by category and location. Which products pull their weight.
• Aging payables. Which vendor bills are due.

Look at margin, inventory turns, payroll as a percent of sales and cash on hand. A store can show a profit and still run out of cash because it bought too much stock. Our article on cash flow vs. profit explains why.

When accounting points to a funding need

Good books show whether a cash shortfall is temporary or structural. Use them to decide on inventory financing, a line of credit or working capital.

Seasonal buying, new locations and big orders put pressure on cash. Your reports tell you if a gap is short-term. If so, financing may bridge it. Illustrative example: you need $40,000 of holiday inventory that should sell for $90,000, with $22,000 of gross profit. A funding cost of $3,000 is easy to justify if sales are likely. If the inventory is speculative, be careful.

For retailers, see retail funding, inventory funding payback math and business line of credit. ROI Funder considers 500+ FICO, 6+ months in business and $20,000+ monthly revenue, and well-kept books and three months of bank statements make a file easy to review.