Specific traits associated with accounting in retail compiled in one convenient place.
Every business owner wants to run their business the best way possible. Hiring knowledgeable staff helps, but sooner or later, most business owners will want to learn more about every aspect of their day-to-day operations. Retail business is a complex one to run, with many different lines of actions needing a lot of attention and supervision. Today, let’s take a look at accounting for a retail store, which, as you are rightly guessing, comes with many specific requirements.
Accounting for a retail store – how is it different from basic business accounting?
Every type of business has to keep a clean track of their financial operations, but there is something that sets the retail business apart from other industries. That word is inventory. Tracking your inventory is no easy task, as it has to include the following:
- Calculation of all purchasing costs,
- Monitoring the number of each item in stock.
Both are necessary to perform correct accounting. So, here you can see the main difference between basic business accounting and accounting for a retail store – it is the need to calculate and track inventory.
How to do accounting for a retail store?
Since inventory is central to accounting in retail, you can start by choosing the inventory costing method that fits you the most to track the cost of the goods you sell and the value of the inventory you have left. There are several methods of calculating the inventory costs, and here I will cover the three among the most popular ones.
The retail method
The retail method is a traditional method of handling retail accounting. It uses the cost to retail price ratio to estimate the value of your ending inventory. It calculated by going along the following steps:
1. Add up the retail value of beginning inventory (A) and retail value of goods purchased (B).
2. Subtract total sales within the given period (D) from the retail value of goods available for sale (C).
3. Calculate the cost to retail price ratio (formula given below).
4. Multiply the difference obtained in step #2 and the cost to retail ratio from step #3 to obtain your estimated cost of ending inventory.
Advantages and disadvantages of the retail method
It’s a quick and easy way to produce an estimate needed for budgeting and financial forecasting. It is, however, only an estimate, and only works perfectly when all prices are the same across different locations (if you have multiple), and any changes occur at the same rate.
In most cases, this method won’t be realistic because of changes in product pricing. It also will not account for any damages, theft, or depreciation, that’s why it best serves only as an estimate.
First in, first out (FIFO)
First-in, first-out is a method used to count the costs of ending inventory that pays attention to the cost flow. The FIFO method assumes that the costs of inventory purchased first will also be recognized first. The value of total inventory will decrease in this process.
Here is a good example of how the costs are counted using this method:
If 50 items were initially purchased for $5 and later on 50 more items were purchased (or produced) for a total cost of $7.5, FIFO would assign the cost of the first item resold of $5. After 50 items were sold, the new cost of the item would be considered $7.5, regardless of any additional inventory purchases made, as it is assumed that the oldest inventory is sold first.
Advantages and disadvantages of the FIFO method
FIFO is the most popular method used in the U.S. It is quite simply a common sense that shows that the oldest goods should be sold first, while the most recently purchased items remain in inventory to be sold at a later stage. There is another method that can be used, however, and there are certain types of businesses that would find it more fitting.
Last in, first out (LIFO)
LIFO is the exact opposite of FIFO. Using the LIFO method, the last items bought are considered to be the first ones sold. The cost of sales is therefore determined by the cost of items purchased the most recently.
You can calculate the COGS (cost of goods sold) using the LIFO method by determining the cost of your most recent inventory and multiplying it by the amount of inventory sold.
Advantages and disadvantages of the LIFO method
LIFO is only legal in the U.S. and is often used when the prices have gone up, and the retailer wants to decrease his or her tax amount. It would eat into their profits but would help in paying less in taxes for an inventory purchased at a costlier price.
How do I keep track of the inventory on hand?
You will be relieved to know that the process you’ve just read about is one of the most difficult ones, so if you’ve managed to put it behind you – well done! The next thing is easier to do – the task at hand is figuring out how to keep track of the amount of inventory you have in your stock. This is very important not only from the accounting perspective but also in making sure your revenue grows, as having enough products to meet customer demand is crucial to be able to continue to answer your clients’ needs. It also helps you keep accurate records that will be important for other accounting purposes that we will cover below.
Keeping a neat inventory can save time at the end of the year when you’re preparing tax statements, and it also assists you in keeping track of your profits and revenue.
Unless you would prefer to do more work manually, the way to track the inventory in stock is using the perpetual method, which allows you to keep track of the items you sell as changes occur. This can be done automatically when you have a fully integrated point-of-sale (POS) system.
If you sell online using PayPal, Stripe, or Square, you might not need a separate POS. You can set up a smart auto-tracker in the background to enter all changes directly into your accounting software instantly after a sale has taken place (more on that below). If you sell offline, you will have to acquire a POS system where each item will be assigned a barcode. When the item is sold, and you scan its barcode, the numbers in your inventory will update automatically. It can save you a lot of time and effort.
Pro tip: Even with a perfect POS system, it will still be necessary to come back to your inventory stock once in a while, on a monthly, quarterly, or yearly basis to account for any loss associated with damage, theft, or depreciation.
What does the accounting cycle look like for retail stores?
Once you’ve gotten the process of choosing the inventory costing method behind you and have set up a smart system to keep track of inventory on hand, you can focus on fine-tuning the accounting cycle. It consists of the following milestones:
- Recording transactions
Professional accountants like to say that the tax season never ends. A secret to a stress-free tax period lies in a diligent process of recording all income and expense-related transactions all year round.
Using accounting software is highly recommended as it often has unbeatable third-party integrations that allow automating the process of transaction recording. (I will overview the most popular tools later in the guide.) Imagine never having to worry about keeping or losing any receipts. It can be done if you use accounting software, which will also allow you to auto-categorize all transactions – a necessary step for minimizing your tax bill and filing proper returns.
- Generating financial statements
Three necessary statements will form the basis of your accounting cycle: an income statement, a balance sheet, and a cash flow statement. These financial statements are a must for every business, not only retail stores:
- Income statement
The income statement is a place to track revenue that your business is earning. For retail, this is mostly going to be a report on how much customers are buying your goods. You subtract the cost of goods sold that you’ve calculated using one of the methods detailed above from the revenue in order to generate the profit you’ve earned, which can be used to cover outstanding operational costs. You can also track your expenses – like rent or payroll using the income statement.
- Balance sheet
The balance sheet is a concise summary of the assets, liabilities, and equity your business possesses at a given period. It sheds light on the financial health of your business, allows you to plan the next steps, and cooperate with potential investors. The total cost of your existing inventory will be important to take into consideration at this point.
The main difference between balance sheets and income statements is that where income statements cover a period of time such as a week, month, or a year, balance sheets are produced for an exact date and time.
- Cash flow
The cash flow statement is similar to your income statement, but the main difference is that it takes into account when the cash actually gets paid to you. It’s important because you are likely to have invoices that won’t be due on receipt, and this report will be vital for knowing what the curve of the cash flow in your business looks like and when you can afford to bear additional expenses, as well as when to replenish your stock without hurting your cash balance.
- Reconciling transactions
The final step in the accounting cycle of a retail store is the balancing of the books, usually performed on a monthly basis, in order to reconcile your records with the actual balance on your business account. When you perform the reconciliation you validate the entire accounting cycle performed beforehand. It is during reconciliation that any discrepancies, errors, and unauthorized expenses come to light. Reconciliation also ensures that filing your taxes is made easier. You can learn more about reconciliation in this detailed guide.
What can I do to automate the accounting? Best accounting software for a retail store.
First of all, you might want to look into automating the process of recording transactions and producing accounting reports. You can look at some of the best accounting software for small businesses – QuickBooks Online, Xero, and FreshBooks to decide which one will work best for you.
The next step is equipping your business with smart add-ons, which will allow you to take the automation even further and eliminate risks associated with manual data entry. If you sell your products online, Synder is one such example. It will automatically bring transaction data from Stripe, PayPal to QuickBooks Online and Xero in the background, putting transactions in the right categories for the items you have in your accounting system and even updating the inventory for you automatically if your sales receipt contains item information.
Accounting for a retail store isn’t the easiest one, as it combines various lines of actions. You have to choose the fitting method of counting the inventory costs, track the inventory on hand as well as manage other processes typical for any type of business (recording income and expenses, producing accurate financial statements, performing accounting reconciliation – all in order to keep an eye on the health of your business as well as to be ready for tax-filing).
But as you can see, some of these actions will only seem complex in the beginning. In fact, many of them can be managed in the background once you have smart workflows in place, ensuring that you utilize automation to save money and time.