Retail Inventory Method; Definition and Calculation

Doing a physical inventory check is one of those things that nobody likes doing but unfortunately, it is absolutely necessary. Over the years, there have been different solutions to the issue. One of those solutions is the Retail Inventory Method. 

What is the Retail Inventory Method then? In the simplest terms, we can explain it as a means of doing inventory by using simple math. It is an alternative method for regular physical inventory checks. The retail inventory helps owners estimate the value of the goods they have utilizing basic math. 

So, how exactly the retail inventory method is an alternative to doing old school style inventory?  First of all, the amount of time and effort needed by both processes differs hugely. Another distinction between the two processes is the requirement to stop the business for a day while doing regular inventory. However, the regular inventory method never requires owners to close up their shop for a day. Instead, they utilize math and do their inventory in merely minutes.

Until now, we talked about how beneficial this method is for businesses. So why not everyone uses it anytime they need to do an inventory check? Because the retail inventory method is just an educated guess for your inventory. The retail inventory method shines in the short term. Depending on the retail inventory method for a long period of time will not be a very ideal thing to do for the business.

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Advantages and Disadvantages of Retail Inventory Method

As we mentioned before, the most obvious advantage of this method is how almost no effort it takes for such an important task. This is such a huge benefit of the retail inventory method that leads to other good things for your business. For example, because it only takes minutes, you do not need to shut down your business for a day and cut that expense. 

Another benefit of the Retail Inventory Method is that it allows you to find out the estimated value of your business in a short time. 

When it comes to the disadvantages of the retail inventory method, the most obvious thing is that this method just gives you the estimation of the value of your goods for sale. So, if you need a precise count of your inventory, you should stay away from this method.

One other shortcoming of the retail inventory method is that it cannot account for stolen, lost, or broken goods you have available for sale. This is just another thing that makes retail inventory account not completely reliable. 

However, all these disadvantages should not steer you away from the Retail Inventory Method. Although it is not the most reliable way of doing inventory, it is still the fastest way to do it.   

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 What is the Most Common Retail Inventory Method?

The most common method is the one which we have been talking about until now. Yet we have not really talked about the process of retail inventory method. 

The first thing you need to calculate to find out more about your inventory is your product’s cost to retail ratio. To find out the cost of a product to retail ratio, you need to take the cost of the goods in your inventory then divide it to the retail value of the same goods for sale. 

For example, let us assume you sell $200 air pods which have a cost of $150 for you.  The cost to the retail ratio for those air pods are %75 (150/200) 

How is inventory value calculated?

We discussed the cost to retail ratio but how do we utilize it for retail inventory? 

Let’s continue from our earlier example of air pods. 

The first step is calculating the cost to the retail percentage, so it is %75 (150/200)

Next, you need to calculate the cost of goods available for sale and the other purchases along the way. Let’s assume you had $50.000 worth of goods and spent $10.000 in other purchases. (50.000+10.000)

The third step is calculating all the sales you have done so far and reaching your costs of sales thanks to the cost to retail percentage. Once again, let us assume you have sold 20.000 worth of goods so far. (20.000 x %75) 

Then you can extract the costs of sales you had so far from the cost of the goods you had available for sale. (60.000-15.000)

We can then reach the conclusion that you have $45.000 worth of goods for sale left in your store.

Which businesses can adopt this method?

As we mentioned before, you can always utilize it, however, you must not rely on it completely. There is nothing better and more accurate than a good old inventory check. 

For some businesses, the retail inventory method is just what they need. Those businesses are the ones that will not hurt with little miscalculations.

Another type of business that can use the Retail Inventory Method is the ones that do not really have any transition of goods in progress most of the time. 

 Overall, knowing this method will never hurt your business. It will never take the place of a regular inventory check yet. it still has its own perks. Those perks can be very beneficial for you and your business in the short term.

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