In plain English
Inventory moves to cost of goods sold when sold. Count it periodically and compare to the books.
Costing method (such as FIFO or average) affects profit.
Why it matters
Inventory sits between cash and profit. Money spent on stock leaves the bank right away but only becomes an expense when the goods sell. If the inventory balance in your books is wrong, your cost of goods sold is wrong, and so is every margin you calculate from it.
Banks that lend against inventory often want a recent count and a listing by item. A balance nobody has counted in years is hard to defend, and an overstated figure can surprise you with a large adjustment at year end.
Worked example
Stock counted at $59,800 versus books of $62,000 shows $2,200 of shrinkage.
How to handle it
- Decide whether your software will track quantities item by item or whether you will adjust a single inventory account after each count.
- Record stock purchases to the inventory asset account rather than straight to an expense.
- Count physical stock at a set date, ideally when no goods are moving in or out.
- Compare the count to the book balance and post one adjusting entry for the difference, with the count sheets attached.
- Ask your accountant which costing method to use and keep using it consistently.
Common mistakes
- Expensing every stock purchase when it is bought, which makes busy buying months look like losses and quiet months look too profitable.
- Skipping the year-end count, so damaged and missing items stay on the books as if they could still be sold.
- Counting goods that belong to a customer or that a supplier has not yet delivered, which overstates the balance.
Not the same as: Cost of goods sold (COGS)
Inventory is goods you still hold, so it is an asset on the balance sheet. Cost of goods sold is the cost of goods that have left through sales, so it is an expense on the income statement. See Cost of goods sold (COGS).
Go deeper
- Inventory Counts and Shrinkage: Keeping Stock Honest: How to run a physical inventory count, reconcile it to your books, record shrinkage, and reduce losses from theft, damage and errors.
- Inventory Costing: FIFO, LIFO and Average Cost: Compare FIFO, LIFO and weighted average inventory costing with a simple example, and learn how the method changes profit and taxes.
Try it
Related terms
- Invoice: A bill sent to a customer for goods or services, with the amount due and terms.
- Journal entry: A manual accounting entry with equal debits and credits, used for items software does not create.
- Income statement (profit and loss): A report of revenue and expenses over a period that shows net profit or loss.
Common questions
What is an inventory?
Goods held for sale or materials used to make them, recorded as an asset until sold.
Can you give an example of inventory?
Stock counted at $59,800 versus books of $62,000 shows $2,200 of shrinkage.
Do service businesses need an inventory account?
Usually not, unless they keep supplies or parts that are resold to customers or used up on specific jobs. If the amounts are small, many service businesses simply expense supplies when bought; check with your accountant.
What do I do with items that are damaged or out of date?
Count them separately and value them at what they could realistically sell for. The reduction goes to an expense such as an inventory adjustment or obsolescence account, with a note explaining why.
General information, not tax, legal or accounting advice. Confirm rules with the IRS, the NJ Division of Taxation or a licensed professional.