Inventory is constantly moving, often passing through multiple work-in-progress stages and crossing multiple months. A few key practices can help in capturing this dynamic process to generate timely and accurate financial performance data.
Rolling stock on hand vs. monthly opening and closing stock.
For many businesses, determining an opening and closing stock on hand valuation at precisely the end of the month is extremely elusive. Not just because inventory is constantly moving, but also because operations staff can often neglect to complete the paperwork required to get the inventory up-to-date. Rolling stock on hand, that is increased by purchase orders and reduced by cost of goods sold (COGS) when a sale is completed, is a method that has two big benefits: a) it can provide an accurate Profit and Loss (P&L) throughout the month and b) the P&L is generated by sales and COGS therefore bypassing the need to have the total stock on hand value precisely accurate at one point in time each month.
When sales and COGS cross different months.
The ultimate rule that should be followed rigorously is ensuring COGS are posted to the month in which the sale is invoiced. If a sales order is invoiced on the 30th but the COGS are calculated in the following month, then those COGS should be posted back to the month of the sale. This avoids a mismatch of sales and COGS between periods.
Quicker to land products than to calculate landed costs.
The goods have been sold and dispatched as soon as the container lands in port but you have no clear landed costs. Your supplier and Customs are quick to get you to pay. The difficulty is the transport companies. They can sometimes bill you 2 to 6 weeks after they have transported your goods. In this case, it is recommended to calculate the landed costs with costs you have immediately available. This can give you a fairly accurate P&L for the current month. When all the costs have been determined, 2 to 6 weeks later, recalculate the landed costs and add the difference to the COGS and post it to the relevant month.
Batch those cash sales.
The detail of each and every internet or retail cash sale is often not required at the accounting level. Those types of cash sales could be batched daily by payment method within the inventory or retail software before it gets imported into Xero. Proper batching of sales will make reconciliation a breeze as the batches of sales should match the amounts received in the bank feeds.
Deposits, deposits, and deposits.
Customer deposits are to be considered as prepayments and classified as a liability. When the goods have arrived and dispatched to the customer then it can be recognized as income. However, if you are catering for the high volume retail market you may need to bend the rules. It is time consuming to create an account and apply a prepayment for each retail customer (normally, lay-buys). In this case, deposits can be batched with the rest of the payments as sales and recognized as income. COGS are still calculated when the sale is finally completed.
Bypassing work-in-progress inventory.
Capturing work-in-progress inventory is labor intensive and often involves a lot of guess work. For projects or sales transactions that span less than 2 to 3 months, it is simpler to recognize the sale in the month of completion and apply all costs of the sale in the same month. If the project is centered on delivering a finished product, you may not be able to recognize the income until the sale is complete, giving more support to undertaking the final cost calculations upon completion and therefore bypassing the need to consider work-in-progress.
Less accounts offer more.
Where possible use the minimum number of accounts (for example Stock On Hand, Direct Purchase Expenses, Sales, Stock Shrinkage/Adjustments and Cost of Goods Sold) to financially keep track of your inventory. It’s easier to maintain and keep the P&L and balance sheet uncluttered. Inventory is ever changing and needs the flexibility to change. Therefore leave the complexity of which products, category of products and customers are profitable to the inventory software.
Adopting some of these practices can ensure both accounting and inventory play together happily and allowing each to do their job with minimum cross department interference.