Definition: The retail inventory method is an accounting system to estimate the ending inventory and cost of goods sold. Essentially, it’s used to estimate the amount of ending inventory at cost.
What Does Retail Inventory Method Mean?
Since the retail business is dependent on carrying inventory and moving new product, it’s important for them to keep track of their inventory on a weekly or monthly basis. This type of reporting can be extremely time consuming, so the retail inventory method is often used to short cut the process and make an estimate rather than taking a physical inventory count.
This method has three steps.
Step 1: Calculate Ending Inventory at Retail
The ending inventory for the period must be calculated. The net sales of retail goods are added up and subtracted from the goods available for sale at retail price. This equation gives us the ending inventory at retail price for the period.
Step2: Calculate Cost to Retail Ratio
Now we add up the goods available for sale at cost and divide it by the goods available for sale at retail (the same number we used in step 1). This equation will give us the ratioof how much we paid for the inventory compared with how much we will be able to sell it to customers.
Step 3: Calculate the Estimated Ending Inventory at Cost
Now all we have to do is multiple the results from step one and two. Ending inventory at retail multiplied by the cost to retail ratio will give us the estimated ending inventory at cost.
This might sound like a lot of work, but it’s much faster than trying to physically count inventory every week or month. Plus, most accounting systems or programs that manage and track inventory will have a built-in module that automatically does the calculations.