Why small businesses should double check inventory for the new year

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Where did your cash go?


You started the year with a sufficient cash balance, and you’ve been profitable each month. For some reason, the year-end cash balance is lower than where you started.


How can that be?


Accounts receivable and inventory can tie up a large amount of cash, and the receivable problem may be easier to fix than your inventory issue.


To reduce your receivable balance and collect cash, you can improve your collections efforts and invoice customers faster. If you have too much cash tied up inventory, the problem is more complex.


Inventory management is a balancing act for every small business.

Filling orders, using cash

Your decisions about inventory have a huge impact on your ability to increase revenue and profits.


Filling customer orders is a high priority, and your firm needs inventory on hand to fill orders quickly and reliably. If you can meet customer expectations, you can generate repeat business, which helps you increase revenue without spending marketing dollars to find new clients.


But, maintaining a sufficient inventory balance requires a cash investment. If you invest cash for inventory, you’ll have less cash to spend on payroll, marketing, and other costs.


Before you can dive into fixing your inventory process, you need to know the basics.

Inventory formula

Plan for an ending balance in inventory at month end, in order to fill customer orders in the first few days of the next month.

The formula for ending inventory is:


(Beginning inventory + purchases – sales = ending inventory)


The desired ending inventory balance is often based on a percentage of monthly sales.


Here’s an example:

A hardware store’s beginning inventory balance of lawn mowers is 50 units, and the company forecasts 300 mower sales for the month. If the business wants 30 mowers (10% of expected sales) in ending inventory, the number of mowers purchased should be:

(300 projected sales + 30 ending inventory – 50 beginning inventory = 280 purchased).


Use the ending inventory formula to maintain a sufficient amount of inventory items and plan for purchases.


The hardware store is a retailer that purchases inventory. The inventory system for a manufacturer is different.

Manufacturing costs

A manufacturer separates the inventory balance into three categories.

  • Raw materials: Items purchased for production
  • Work-in-progress (WIP): Partially completed goods
  • Finished goods: Goods that are ready for sale

If you own a towel manufacturer, the cotton you purchase to make towels is a raw material. Towels that are partially completed, but missing labels, are assigned to WIP. Finally, towels that are packaged and ready to be shipped to customers are finished goods.


The costs incurred for all three categories make up the total inventory balance.

Meet Julie, an owner who manages inventory

As an example throughout, meet Julie. She owns Sunshine Greeting Cards, a business that sells greeting cards, candles, and other gifts. The company sells items through its website, and in three retail store locations.


Julie has operated Sunshine profitably for six years, and grew the business from one to three stores. Company growth has led to some problems with inventory:

  • Purchases: Sunshine has made some inventory purchases that weren’t needed.
  • Stockouts: A stockout occurs when Sunshine runs out of a particular inventory item, and can’t fill a customer order. Stockouts frustrate customers, and Sunshine runs the risk that buyers may not return.
  • Inventory costs: Sunshine needs a better system for tracking the cost of each inventory item. If Julie can’t nail down the cost of a particular item, she can’t price the product to generate a reasonable level of profit.

To resolve these problems, Julie performs a review of her entire process, starting with inventory purchases.

Managing inventory purchases

Every business should maintain a written procedures manual for routine tasks, and the manual should include specific procedures for purchasing and managing inventory.


A procedures manual ensures that routine tasks are completed in the same manner each time, and the manual allows your staff to train new workers effectively. Here are some key steps to control inventory:

  • Purchase orders: Each inventory purchase should be requested using a written purchase order, and a manager must approve each purchase. This control prevents a company from ordering more inventory than is needed.
  • Recording the purchase: The accounting department should match the purchase order with the shipping documents that verify receipt of the inventory order. A company should record the cost and a full description of each inventory item, so that the accounting records can be used to perform a year-end physical inventory count.
  • Processing a sale: When a sale is recorded, inventory is reduced and cost of goods sold (COGS) is increased. Your accounting software should be able to post a sale and a corresponding reduction in inventory automatically.

Because a company may process dozens or even hundreds of sales each month, it’s critically important to make accurate and timely updates to the accounting records.


Accounting software allows a business to use a perpetual inventory system. Perpetual means that the inventory, sales, and cost of goods sold accounts are updated automatically with each transaction.

The next step is to consider how to accept payments for purchases.

Using a POS system

The most important function of a POS system is to process a customer payment, and complete a sale.


Here are the steps required to complete an online sale, using the services of a payment processor:

  • Customer selects item: The customer selects an item for purchase by clicking on the item and moving to the checkout screen.
  • Entering card data, purchase: At the checkout screen, the customer enters their credit card or debit card information, confirms the dollar amount of the purchase, and clicks a purchase now button.
  • Processing payment: The payment processor charges the customer and sends the sales price amount, less the processor’s fee, to Sunshine’s bank account.
  • Confirmation: The payment processor confirms the transaction to both the customer and Sunshine electronically, so that both parties have a record of the sale.
  • Product shipment: Once the payment is confirmed, Sunshine Greeting Cards sends the items purchased to the customer.

In addition, the payment processor must be able to handle refunds, sales price corrections, and other changes to a customer order. Sunshine also must be able to use the same technology at POS terminals in each store location.


Your POS system can be your most effective tool for managing the movement of inventory items.


For most retailers, inventory is the biggest asset balance listed on the balance sheet, and also the largest use of cash. It’s important to find a POS system that provides inventory management capability, because a lot is riding on your ability to monitor inventory levels.

Inventory Transactions

One of Sunshine’s best-selling products is a Seaside Candle, which sells consistently each month. When the candles are purchased and received at the company’s warehouse, the candles are assigned SKU number SEACAN12.


SKU numbers are alphanumeric codes used by companies to track units of inventory, and Julie tracks the number of items in inventory by SKU number.


Here’s where a good POS system can help.


When an item is sold, the POS system reduces the inventory level for that particular SKU number- automatically. If Sunshine sells 20 Seaside Candles on Tuesday the 12th, for example, Julie can pull a report from the POS system and immediately know her new inventory levels.


The POS system allows Julie to closely monitor inventory levels, so that she can carefully plan her inventory purchases and conserve cash. If the business consistently sells 300 candles a month, Julie can use that information to make purchases, and avoid buying too much inventory.


It’s also important to track the cost of each inventory item, which brings us to inventory valuation.

Valuation of inventory

If an inventory item is worth less than what you paid for it, you must adjust the cost down to the current market value.

Accountants refer to this rule as the lower of cost or market, and the policy is consistent with the principle of conservatism. If the dollar value of inventory has declined in value, the amount must be adjusted in the financial statements.


If you apply the lower of cost or market policy, the financial statements will be more accurate.


Sunshine sells every inventory item within six months, and Julie does not purchase items that decline in value over that period of time. The bigger issue for Sunshine is determining which specific items were sold, and the original cost.

First in, first out method

The first in, first out (FIFO) method assumes that the oldest items in inventory are sold first.


The current inventory of Seaside Candles includes these purchases:

  • 50 candles purchased on Dec 1st for $10 each
  • 25 candles purchased on Dec 15th for $12 each
  • 75 candles purchased on Dec 20th for $13.50 each

If Sunshine sells a total of 40 candles on December 25th, the FIFO method values the candles sold at $10 each.


Most companies use the FIFO method to value items sold out of inventory. Some firms, however, use last in, first out (LIFO) method.

Last in, first out method

To understand the LIFO method, think about buying milk at the grocery store.


The oldest gallons of milk are pushed to the front of the refrigerator, so that you’re more likely to buy the older product before it expires. To get to the newer milk, you have to reach behind the old stuff.


Getting to the newer milk is the LIFO method.


LIFO assumes that the newest units are sold first. If Sunshine uses the LIFO method, the 40 candles sold on December 25th are valued at $13.50 each.


Accounting principles require that you consistently use the same method, so that your financial results are consistent from year to year. Fortunately, accounting software can track the costs and post the correct amounts automatically.


The best way to confirm that the accounting records are correct is to perform a physical count of year-end inventory.

Physical inventory count

Businesses typically conduct an inventory count at the end of an accounting period, such as a month or year.

Timing of the count

A year-end inventory count, however, confirms that the accounting records match the physical inventory items on hand at the end of the year, when you generate the annual financial statements.


If a CPA firm is conducting an audit of the December 31st financial statements, the accountants will count the physical inventory on the last day of the calendar year. If the auditor cannot access inventory on 12/31, the firm will count inventory as close to the end of the year as possible.


The purpose of the physical count is to agree the detailed inventory listing from the accounting system to the physical inventory units on hand.

Performing the count

Sunshine follows these procedures to ensure that the December 31st inventory count is accurate:

  • Accounting listing: Julie’s accountant prints a detailed listing of the firm’s inventory on December 31st, and distributes the listing to each person who is counting inventory.
  • Inventory access: Company management notifies the warehouse staff that no inventory should be received after 5pm on December 30th. Access to the warehouse is restricted on the 31st, so that no inventory is moved in or out of the facility on the day of the count.
  • Numbered Tags: Each inventory item is tagged, and the tag lists the cost, description and the number of inventory items (if applicable). The tags are numbered and listed on a separate report that is also provided to each person who is counting inventory. Larger items are given a single tag, while smaller items (a box of greeting cards) have a tag attached to the box of items.
  • Matching: Julie and her staff match each item on the detailed inventory listing to a tagged item. Each counter writes the tag number next to the item on the inventory listing. If the information from the tag differs from the inventory listing (cost, number of items in a box), that information is also noted on the listing.
  • Exceptions: Julie and her staff investigate any differences, so that the inventory record can be corrected. If, for example, the physical count reveals a box of 50 greeting cards rather than 100 cards, the inventory records are adjusted. The sum of all the adjustments will ensure that the inventory listing matches the physical inventory on hand.

After the count is completed and the accounting records are adjusted, Julie’s inventory balance will be corrected stated in the balance sheet.


Accounting for inventory impacts your cash balance, the amount of profit you generate, and the business tax return. It’s time consuming, but business owners will see a benefit from managing inventory more accurately.


Julie’s changes have fixed the inventory problems, but what can she do to keep things on track next year?

What to do next

Talk with everyone on your staff, and document all of your current inventory procedures. Create a FAQ sheet for your staff, so everyone understands how to manage inventory. Move away from manual tools, and embrace technology, including a POS system.


Most important, perform inventory counts on a quarterly basis. The actual count for year-end inventory should take place as close to 12/31 as possible.


As your business grows, managing inventory will be more complex. Put a great system in place now, so you can move forward with confidence.


This article originally appeared on the Quickbooks Resource Center and was syndicated by MediaFeed.org.




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Home businesses tax deductions to take as a small business owner


Small business owners take on a considerable amount of responsibility. Beyond serving clients, they must also take care of all the minutiae of running a business, including keeping track of expenses they can deduct as a small business owner.

Fortunately, small business owners and entrepreneurs who use their home for work can benefit from various home business tax deductions that help them reduce their taxable business income. Common deductions include office supplies, software and internet access, but deductions can vary widely depending on the type of home business you run.

  • Who qualifies for home business tax deductions?
  • 25 home business tax deductions for your small business
  • How to write off home business expenses




If you run your business out of your home, you may be able to deduct expenses for the use of your residence on your taxes for your small business. The home office deduction can be utilized by homeowners and renters, and any type of residence can qualify (single-family home, condominium, manufactured housing, etc.).

To qualify for the home office deduction, your home business activities must meet the following criteria:

  • Regular and exclusive use. According to the IRS, you must “regularly use part of your home exclusively for conducting business.” In other words, you must have a space in your home that you use only for business purposes, such as a home office or extra room that is used only for business and never for personal use.
  • Principal place of business. To qualify for the home office deduction, your home also must be the principal place your business operates from, although there are exceptions. The IRS reported that you may qualify for the home office deduction if you also have a business location outside of your home, provided you use your home for a substantial component of your business. For instance, if you conduct business in another location but have meetings with clients or patients in your home, the IRS allows you to deduct expenses for the part of your home that you use “exclusively and regularly” for business purposes.

There are some exceptions to these rules, including for those who run a home daycare. If your small business involves watching children in your home, then it would be impossible to meet the “exclusive use” criteria if you’re watching children in your own living area. To qualify for this exception to the exclusive use rule, you must provide daycare for children, persons age 65 or older or persons who are unable to care for themselves. Additionally, you must have “applied for, been granted or be exempt from having a license, certification, registration or approval as a daycare center or as a family or group daycare home under state law,” noted the IRS.




If you’re eager to reduce your taxable income this year, figuring out which home business tax deductions you can take is a smart first step. Here are 25 common deductions you may be able to qualify for.




Business supplies and office expenses, such as office furniture, printer paper, pens, calculators and business cards, are deductible provided they are for business use. According to the IRS, business expenses must be both ordinary and necessary, meaning they are “common and accepted in your trade” and “helpful and appropriate,” though not necessarily indispensable.




Small business computers and software you need to purchase for your business, including small business accounting software, should be tax-deductible business expenses provided these purchases are ordinary and necessary for your business to remain in operation.




You may also be able to deduct home repairs and maintenance performed on your place of residence, but only for the part of your residence that is used exclusively for business purposes. According to the IRS, an example could include “painting or repairs only in the area used for business,” like a new coat of paint or replacement flooring in your home office.




You can deduct the business portion of your rent as an expense if the property you rent is for use in your trade or business. However, you cannot deduct rent as a business expense if you have or will receive equity in or a title to said property. Per the IRS, rent is defined as “any amount you pay for the use of property you do not own.”

In terms of depreciation, the IRS said that you can typically deduct depreciation on the business use portion of your home as well, in an amount up to the gross income limitation over a 39-year period.




If you have a home office, your house utilities will also be required for your business. As a result, you can deduct a portion of your utility bills, such as gas and electric bills. However, you can only deduct a portion of these expenses since, obviously, part of your utility bills are for personal use.




If you use your car for business purposes, you can deduct auto-related expenses for the business use of a car. The IRS also reported that, if you use your car for both personal and business use, you must divide your car expenses based on the mileage you drive for personal and business purposes.




You can also deduct mileage for all travel related to business. The IRS offers a table of standard mileage rates and mileage deduction rules you can refer to for the last several years, including mileage expenses for 2020.




You can also write off employees’ pay as a small business owner. This is true even if you operate your business out of a home office.




You can also deduct contributions to retirement plans, including tax-advantaged retirement plans for the self-employed or small business owners, such as an SEP IRA or a solo 401(k).




If your business is paying interest on a credit card or loan that you borrowed for business activities, you should also be able to deduct this interest as a business expense.




According to the IRS, you may be able to deduct various federal, state, local or foreign taxes that are directly related to your trade or business.




You can typically deduct the cost of business-related insurance products you pay for, provided they are applicable to your trade or profession.




If your business creates products or purchases them for resale, you can typically deduct the cost of these products or the costs involved in manufacturing them. This can include the cost of raw materials, freight, shipping, storage, direct labor and more.




Thanks to the Tax Cuts and Jobs Act of 2017, you may be able to deduct up to 20% of your qualified business income on your taxes. This deduction does have limitations based on your trade or business as well as how much you earn, however. Specifically, joint tax filers with incomes below $315,000 and other filers with incomes below $157,000 can claim this deduction in full provided they work in a qualifying industry. For 2018, joint tax filers with incomes between $315,000 and $415,000 and individuals with incomes between $157,000 and $207,500 were subject to phase-outs.


Jelena Danilovic/istockphoto


If you use your home for business purposes, you can generally deduct cleaning services and supplies that you purchase for the business-related portion of your home.




If you own your home and have a home mortgage, you can deduct a portion of your mortgage interest on your business taxes. Deductions are based on the percentage of your home that you use for your business. If your lender requires mortgage insurance, part of that can be deducted as well.




Business-related travel expenses can also be taken as a business expense. This could include travel to meet with clients or to professional education or training events.




If you pay for professional services, such as legal advice or tax preparation, these expenses can be deducted as business expenses.


Jacob Ammentorp Lund/istockphoto


If you pay for marketing help or a business coach, these expenses can be deductible from your business income.




If you ship items for business purposes, shipping costs can be deductible on your taxes. The same is true for postage when used for business purposes.




A security system that protects the doors and windows in your home from intruders can also be partially deductible as a business expense, provided part of your home is used for business purposes.




Professional memberships you pay for and subscriptions to business-related publications can also be tax-deductible.




The IRS said that while the first local telephone landline in your home is not a deductible business expense, “charges for business long-distance phone calls on that line, as well as the cost of a second line into your home used exclusively for business, are deductible business expenses.”




Health insurance for yourself and your family is deductible as a business expense when you’re self-employed, although you do not have to have a home office to qualify for this deduction.




If you pay for or reimburse education expenses for an employee, you can deduct the expenses if they are part of a qualified educational assistance program, per IRS rules.




If you’re feeling overwhelmed by all of the home office business expenses you might have to keep track of, you should know that the IRS also offers a standardized home office deduction that requires less legwork upfront. Here are the two options you have when it comes to how to write off home office business expenses this year:

  • Simplified home office deduction: Since the 2013 tax year, taxpayers have been able to access a simplified option for computing the home office deduction. This option lets you determine a standard deduction based on the square footage of your home office space, thus letting you avoid tracking and reporting all of your individual home office expenses. Of course, the simplified method isn’t perfect since you can’t take some deductions like depreciation. You also cannot carry over a loss from a previous year, which is a departure from the regular method.
  • Regular method: If you keep excellent records and prefer to deduct business expenses the old-fashioned way, you are still able to do so. With this method, you would need to keep detailed records of all your actual expenses for your home office including mortgage interest, utilities, depreciation and more. From there, your deduction will still be determined based on the percentage of your home used for business purposes.

If you’re using the regular method, you should plan on using IRS Form 8829 for certain business-related tax deductions when you file your taxes. But be aware that some business expenses don’t fall under the home office deduction, so they would be deductible within other areas of your taxes, such as Schedule C or F. Examples include telephone expenses, dues and salaries.

Also note that if you use the simplified method and itemize deductions, you can deduct some expenses for your home that are otherwise deductible, including mortgage interest and property taxes, as itemized deductions using Form 1040 or 1040-SR, Schedule A.

When choosing which method to use for your home office deduction, keep in mind that both options have pros and cons. The regular method requires a lot more work, but you have the potential for a larger deduction if you have a lot of qualified expenses within a year. The simplified method is easier, but not necessarily ideal if you want to recapture depreciation when you sell your home, or if you want to be able to carry over losses. Make sure you understand each method and its limitations so you can make an informed decision.

This article originally appeared on LendingTree.com and was syndicated by MediaFeed.org.




Featured Image Credit: Deposit Photos.