If you have a business that buys and sells products, your accounting is a lot more complicated than say a dog-groomer or personal coach.
Lucky for you, QuickBooks can handle most inventory based accounting really well. The catch? If you don’t set it up and use it a certain way, your accounting will make about as much sense as an IRS manual.
When it comes to understanding the accounting part about inventory accounting there is actually only one thing you really need to understand – Cost of Goods Sold.
What is Cost of Goods Sold?
Most people understand the concept of Cost of Goods Sold – the name itself is pretty self-explanatory. It is, literally, the cost of the products that you sell. What many people don’t understand about Cost of Goods sold and inventory accounting is how to arrive at a Cost of Goods Sold figure that makes your financial statement accurate and useful.
What many people logically do when they record the cost of the products they sell is simply choose the cost of goods sold account whenever they pay a vendor for the products that they will be selling. This seems as simple as pie, so what’s the problem? Quite a few, actually, if you want to have useful financial information about your business.
First, let’s think about what type of financial information IS useful to an inventory based business. Let’s say we would like to make some plans or understand how our business is doing. Here are some questions that we may ask QuickBooks to answer:
1. How many products do I need to sell to make a profit?
2. What are my most profitable products?
3. Am I making any money?
4. How much stuff do I have that I can sell?
5. Will I have enough money to expand, hire someone, make my next inventory purchase, pay the rent, tomorrow, next month or next year?
Without true answers to these types of questions, you may as well use a cootie catcher to make important decisions about your business.
The good news? If you do it right, the data in QuickBooks can answer all these questions and more. The bad news? If you do it wrong, the data you put in QuickBooks will make you want to poke your eyes out with the nearest letter opener.
In logic, and in practice, inventory accounting in QuickBooks is extremely simple, and it works like this:
- You set up each item that you sell in QuickBooks as an inventory item.
- You use the enter bills or write checks feature in QuickBooks to purchase the items from your vendors.
- You use the invoices or sales receipts feature in QuickBooks to sell the items to your customers.
You must feed the beast – You can only get out of QuickBooks what you put in. When you follow the process above, QuickBooks will very obediently:
- Keep track of how much you originally paid for each item -you fed it this information when you “purchased” the items by writing a check or entering a bill.
- Keep track of how much you sell each item for – you fed it this information when you sold the item to you customer on a sales receipt or invoice.
If you feed the beast, QuickBooks will do all kinds of amazing things for you, answer all of your important questions, and help you make smart decisions. For instance:
- When you look at your profit and loss report, your Cost of Goods Sold will accurately reflect the amount that you paid for each product that you sold that month. * Therefore, your profit (or loss) for that month will make sense and be true.
- Allow you to run dozens of reports about your products – which items do you sell the most of, make the most money off of, how many and/or what types of products you need to sell to make a profit, break even or grow.
- Project your cash flow.
- And much, much more!
Things you should NEVER do:
- Use the write checks or pay bills feature to pay your vendors for items that you sell and post them directly to Cost of Goods Sold.
- Enter payments from customers on a deposit for and post them directly to Sales Income.
Simple, but setting up every item you sell is a lot of work. Why not just use the “Things you should NEVER do” method?
- Bad matching of Sales vs. Expenses: If you purchase $10,000 in inventory in January that you will sell over two months, your January looks pretty weird. Like you lost a lot of money that month, and your February looks like you made a whole lot. This makes no sense and makes it impossible to answer questions like – what are my most profitable months? What is my average margin? (the difference between what I pay for my products and what I sell them for.)
- No computerized inventory: You won’t know at a glance what you have in stock, what you need to order, or how profitable each product is.
Although QuickBooks handles inventory accounting well for most small businesses, there are limitations. It’s also important to really understand what is happening behind the scenes in QuickBooks. I recommend that anyone who is not confident get help from an experienced Pro-Advisor setting up their inventory system in QuickBooks from the beginning.
I’ve worked with dozens of businesses, and those who got help from the start, or as soon as they were out of their league, saved a lot of time and money.