The retail inventory method values a store's stock without looking up what each item cost. You count the shelves at the prices marked on them, then multiply by the store's ratio of cost to retail, the cost complement. Cost complement = (beginning inventory at cost + purchases at cost) ÷ (beginning inventory at retail + purchases at retail + net markups − net markdowns). Ending inventory at cost = ending inventory at retail × cost complement. The conventional version leaves the markdowns out of the ratio, which gives a lower value. In the example below, a gift shop's ratio is 50%, its count of $55,000 at retail is worth $27,500 at cost, and the count shows $5,000 of shrink at retail. Below is each step, the year, both versions, and a free calculator.
The short version
- Add beginning inventory and purchases, each at cost and at retail; add freight to the cost.
- Add permanent markups and take off permanent markdowns on the retail side; temporary sale prices don't count.
- Cost complement = goods available at cost ÷ goods available at retail.
- Count the shelves at retail and multiply by the cost complement: that's ending inventory at cost.
- Book ending inventory at retail = goods available at retail − sales; the gap to the count is shrink.
- The conventional method leaves markdowns out of the ratio, which approximates lower of cost or market.
- TaroStack values stock at what each item cost, from the deliveries received. More below.
The formula
| Step | Formula |
|---|---|
| Goods available at cost | Beginning inventory at cost + purchases at cost + freight in |
| Goods available at retail | Beginning inventory at retail + purchases at retail + net markups − net markdowns |
| Cost complement | Goods available at cost ÷ goods available at retail |
| Book ending inventory at retail | Goods available at retail − sales |
| Ending inventory at cost | Counted ending inventory at retail × cost complement |
| Cost of goods sold | Goods available at cost − ending inventory at cost |
The federal tax rules describe the same thing: a retail merchant may use the retail inventory method, multiplying a cost complement by the retail selling prices of the goods on hand at year end, with the ratio's denominator adjusted for permanent markups and markdowns but not temporary ones (26 CFR 1.471-8). Which method you use for tax is a question for your accountant; this is general information, not tax advice.
An example: a gift shop's year
Cannon Beach Gift Co., a made-up gift shop in Cannon Beach, Oregon, I use in these examples, sells candles, art prints, kites, sweatshirts, jams and chocolates, and cards. Its year:
| At cost | At retail | |
|---|---|---|
| Beginning inventory | $42,000 | $90,000 |
| Purchases | $168,000 | $360,000 |
| Freight in | $6,000 | |
| Net markups | $4,000 | |
| Net markdowns: the end-of-season sale | −$22,000 | |
| Goods available | $216,000 | $432,000 |
| Cost complement | 50.0% | |
| Sales | $372,000 | |
| Book ending inventory at retail | $60,000 | |
| Counted ending inventory at retail | $55,000 | |
| Shrink at retail | $5,000 | |
| Ending inventory at cost: $55,000 × 50% | $27,500 | |
| Cost of goods sold: $216,000 − $27,500 | $188,500 | |
| Gross margin: ($372,000 − $188,500) ÷ $372,000 | 49.3% |
The count took one evening: the staff scanned or read the price on each shelf and added them up, with no cost to look up for any of the shop's 2,400 items. The book said $60,000 at retail should be there and the count found $55,000, so $5,000 at retail, 1.3% of sales, went to breakage, theft and mistakes, $2,500 of it at cost. How to run the count is in how to count inventory.
The conventional method
The conventional version leaves the markdowns out of the ratio's denominator, which makes the ratio lower and values the stock as if what's left would also be marked down, an approximation of lower of cost or market:
| Cost method | Conventional | |
|---|---|---|
| Retail in the denominator | $432,000 | $454,000 |
| Cost complement | 50.0% | 47.6% |
| Ending inventory at cost | $27,500 | $26,167 |
| Cost of goods sold | $188,500 | $189,833 |
| Gross margin | 49.3% | 49.0% |
The conventional method's inventory is $1,333 lower, and the year's cost of goods sold $1,333 higher. Choosing between them is an accounting decision; the calculator shows both.
Between counts
For a month's figures without a count, take the book ending inventory at retail, $60,000, less the shrink rate from the last count, 1.3% of sales: $60,000 − $372,000 × 1.3% = $55,164 at retail, about $27,582 at cost. It's an estimate until the next count checks it.
When it works, and when it doesn't
The ratio is an average, so it suits a store whose items carry similar markups. The gift shop's candles at 55% and its chocolates at 35% average out; a store whose margins are far apart works out a ratio for each department. A maker that produces what it sells has no retail price on its raw materials and work in progress, so it values stock at cost instead; how cost layers work is in FIFO method formula and the average in how to do weighted average cost.
Get the calculator
Download the retail inventory method calculator. One sheet: type beginning inventory and purchases at cost and at retail, freight, net markups and markdowns, sales and the counted ending inventory at retail, and the cost complement both ways, book inventory, shrink, ending inventory at cost, cost of goods sold and gross margin fill in, with an estimate between counts. It's an ordinary Excel file with no macros, and it works in Google Sheets, LibreOffice and Numbers.
Where this stops working
A ratio for the whole shop hides which items carry which margin, and a count at retail says what's missing at the prices on the tags, not which candles walked out. When a supplier's prices rise halfway through the year, the ratio averages it in, and the margin on the items affected is never seen on its own.
How TaroStack does it
TaroStack values stock at what each item cost, from the deliveries received.
Cost from each delivery. Each delivery is received at what it cost, with freight and other landed costs added, in FIFO cost layers or a moving average, so stock value by site and month comes from real costs, with no ratio to estimate.
Counts with their value. Counting on a phone by barcode shows what a variance is worth before you post it, and every loss carries its reason, so the shrink the retail method finds in one number is reported by item and reason.
Margins by item. Margins are reported by product on what each item actually cost, with a price-creep report by supplier.
| The job | Retail method | In TaroStack |
|---|---|---|
| Ending inventory at cost | Count at retail × a ratio | Stock value from actual costs |
| Shrink | One figure at the count | By item and reason |
| Margin | One average for the shop | By product |
| A supplier's price rise | Averaged into the ratio | Price-creep report by supplier |
Stock value, counts, losses by reason and margin reports are on every plan, from $49 a month, with no limit on items; TaroStack connects to Square. The first 30 days are free, with no credit card. If you'd like a hand setting up, ask, and we'll do it with you.