Sunday, October 9, 2011

Inventory and cost of goods sold for your Etsy or crafts business

Inventory and cost of goods sold can be a very confusing subject for many Etsy and crafts shop owners. Crafts makers have challenging issues:
  • They work with large quantities of small items (such as beads)
  • They work with items that are measured in yards or inches (yarn, threads, fabrics)
  • They work with items that have been previously owned personally by the business owner
  • They work with bits and pieces of materials (quilters, recycled or repurposed crafts, etc)
Here are some answers to some commonly asked questions:

Do you have to keep track of inventory?
Generally - yes. According to the IRS, “generally, if you produce, purchase, or sell merchandise in your business, you must keep an inventory.” There are some exceptions to this but unfortunately it does not apply to business owners who have a retail business or sell online.

What does inventory include?
Inventory includes:
  • Products not sold yet
  • Raw materials (materials used to make the things you sell)
  • Work in progress (merchandise that is not completed yet)
  • Supplies used to make the things you sell
How do you track inventory?
According to the IRS, “you must value your inventory at the beginning and end of each tax year to determine your cost of goods sold.”
Here is an easy way to do it:
a.     Do this on or around the last day of the year (around December 31)
b.     Gather items that would be considered inventory
c.      Make a list (quantity, description, and what you paid for it)
d.     Add up the total cost that you paid for it

How do I know what I paid for inventory?
First, you have to keep track of all receipts for your purchases. To determine what you paid for it – look at your receipts. If you don’t have receipts then look up the current cost online. Otherwise make your best estimate and write down that it’s an estimate.

Here are some suggestions that have worked for me:
  • Buy only supplies that you need to complete current orders - don't buy excess supplies
  • Add a note or sticker to the supplies you purchased that includes the date purchased, the store you purchased it from, the quantity purchased and the amount paid. For example, if you are using yarn, then write it on the yarn label. If you are using fabric, then write it down on a piece of paper and use a clothespin to pin it to the fabric. You may want to make yourself a label that looks something like this:

Do you really have to keep track of every little inventory item?
Technically - yes, but you also have to be reasonable. If you are a jewelry maker and you are using clasps or beading wire, maybe that is not major component of your jewelry. Your beads are probably the most expensive. You would probably be okay with not tracking the minor components and classifying them as supplies.

What is "Cost of Goods Sold"?
Cost of goods sold includes the cost of supplies used in making your products or the cost or merchandise bought for resale.  For example, if you make jewelry, then you would include the cost of beads and findings.  If you make crocheted hats, then this would include the cost of yarns and fibers. 

How do you calculate Cost of Goods Sold?
Cost of Goods Sold is calculated using the following formula:
   Beginning Inventory plus Purchases minus Ending Inventory = Cost of Goods Sold.

What are "Supplies"?
Supplies include the cost of small supplies that are not included in Cost of Goods Sold, such as glue, thread, needles, knitting needles, paint brushes, paints, etc.  You can also include the cost of books, and small equipment.  For example, if you make stuffies you would include the cost of needles, thread, buttons, scrap materials, fabrics and stuffing used to make samples.

Can you give me an example of what this looks like in real life?
Yes. Jane had the following activity in her business for the year:
  • $1,000 spent on bead purchases
  • $100 spent on jewelry findings (clasps, bead wire, etc)
  • $250 spent on jewelry display units
  • $300 in inventory at the beginning of the year
At the end of the year, Jane had some beads left. She also had 5 necklaces made which she did not sell. On December 31st, Jane used an inventory worksheet to count all of the beads. Her beads inventory at the end of the year totalled $245. She also calculated the cost of the beads and materials included in the 5 necklaces. This cost totaled $50. Based on this, her inventory at the end of the year is $245 plus $50 or $295.

She had only a few jewelry findings left, which she estimated at $25. She decided this was a minor amount and opted not to count it as inventory.

The jewelry display units are not inventory or cost of goods sold. They are considered supplies.

Her cost of goods sold for the year is calculated as: $300 (beginning inventory) plus $1,000 (purchases) less $295 (ending inventory) = $1,005.
Her inventory at the end of the year is $295.

Do you have an inventory worksheet I can use?
Yes, you can download a free Excel inventory worksheet at my website.

For a free article "10 Things You Must Know About Taxes, Bookkeeping, and Business Licenses" and for free Excel worksheets just for Etsy shop owners and creative entrepreneurs visit my website.

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