A retail business’s regular responsibility is to determine the value of unsold inventory. One way to simplify this process is to use the retail inventory method, which can help you estimate what your merchandise will be worth at the end of the reporting period.

Understanding these methods can help you better manage your inventory or supplies when used in conjunction with physical inventory counts. In this article, we explain the retail inventory method and provide steps and examples of how to use it to estimate your store’s ending inventory balance.

**Contents**

**What is the retail inventory method?**

The retail inventory method is an accounting technique that estimates the value of a store’s stock during the selected reporting period. This calculation uses the cost of merchandise, retail and sales prices to determine the store’s ending inventory balance.

Ending inventory shows the value of your inventory that is still available for sale at the end of the period. Since some merchandise may be lost, damaged, or stolen, this method can only provide an estimate of the value of your inventory. Therefore, you may still need to do a physical inventory count to be more accurate.

Something to consider about the retail inventory method is that you can only use it if you have a consistent retail markup on the merchandise you sell. For example, it will work better if you sell wallets and sell each for 60% of the wholesale purchase price, than if you sell multiple wallets at 100% markup, some at 60% and some at 45%.

This method assumes that the historical markup percentage continues into your current reporting period, so if you have sales that will affect markup, you could get a less accurate calculation.

**Benefits of the retail inventory method**

The retail inventory method is one of several different techniques for determining business ending inventory. These other techniques include the first-in, first-out (FIFO) method; last-in, first-out (LIFO) and weighted average cost (WAC) methods. However, here are some of the advantages that the retail inventory method provides:

**This method does not require physical inventory**. Businesses with multiple locations can estimate the value of their inventory without having to physically inspect available inventory.**This method offers a simplified process.**Performing physical inventory checks can be time-consuming and costly, as you may need to close the business, so the retail inventory method can allow you to do it less frequently because you have an approximate picture of your inventory and its value.**This method helps you create an inventory value report**. The retail inventory method is permitted under Generally Accepted Accounting Principles, so it can be used for tax reporting purposes, and the value report can help determine the value of your business.

**How to use the retail inventory method**

To calculate the value of ending inventory using the retail method, use the following steps:

**1. Calculate the cost-to-retail ratio**

First, you must determine the cost-to-retail percentage of your retail inventory. You will need to know the wholesale purchase price of the merchandise and how much you will sell it for, or the retail price. Use the following formula to calculate the cost-to-retail ratio:

Percentage cost-to-retail = (cost of merchandise / retail price of merchandise) x 100

For example, if you buy merchandise for 40,000, and then sell the merchandise for 100,000, your cost-to-retail percentage is 40%.

**2. Calculate the cost of merchandise available for sale**

When estimating the value of your inventory using the retail inventory method, you need to specify the specific time period for which you will report. Then you need to identify the cost of your inventory at the beginning of that time period.

Further, you will incur the cost of any additional inventory purchases you made during that time period. Using the following formula, you can determine the cost of merchandise available for sale:

**Cost of goods available for sale = cost of your beginning inventory + cost of purchase**

For example, suppose your store has an initial inventory of 15,000,000 and then you purchase 25,000 worth of new merchandise. Adding them up, you see that the cost of merchandise available for sale is 40,000,000.

**3. Calculate the cost of goods sold during the period**

Now you need the total merchandise sales for the time period you selected and your cost-to-retail percentage. You will use this information to determine the cost of goods sold, which represents the total expenses required to sell your merchandise. To estimate your cost of sales during the reporting period, use the following formula:

Cost of sales = sales during the period x cost-to-retail percentage

Using the example from step one, your cost-to-retail percentage is 40%. Say during this selected reporting period, you had sales of 68,000,000. By multiplying the cost-to-retail percentage by the total sales, you see that your cost of sales is 27,200,000.

**4. Calculate ending inventory**

After you calculate the cost of merchandise available for sale and cost of goods sold for the period, you can determine your ending inventory. Ending inventory shows the value of merchandise remaining at the end of your reporting period.

You should include your ending inventory on every balance sheet you create, although you will need to ensure accuracy if you report your business’s financial information when seeking financing.

To estimate the value of your ending inventory using the retail inventory method, use the following formula:

Ending inventory = cost of goods available for sale – cost of goods sold during the period

Using the example from the previous step, you determined that the cost of goods sold was 40,000,000 and the cost of sales during the reporting period was 27,200,000. By subtracting 27,200,000 from 40,000,000, you determine that the value of your ending inventory is 12,800,000.

**Example of retail inventory method**

Here’s an example of how to use the retail inventory method to estimate the value of your ending inventory:

Stefanie wants to determine the eventual value of inventory over the three-month reporting period for her business, Stefanie’s Soapery. He sells bars of soap for 8,000 each, buying them wholesale for 1,500 each. He uses the following formula to determine his cost-to-retail percentage:

(1,500 / 8,000) x 100 = 18.75%

During that three-month period, he had a beginning inventory of 3,000,000 and made 5,000,000 in additional inventory purchases. To determine the cost of merchandise available for sale, he added the two numbers together:

3,000,000 + 5,000,000 = 8,000,000

Stefanie also knows that she made 12,000,000 in sales over the three-month reporting period. He uses total sales and cost-to-retail percentages to calculate his cost of sales:

18.75% x 12,000,000 = 2,250,000

To calculate his ending inventory for the three-month reporting period, he subtracts his costs of selling (2,250,000) from the cost of merchandise available for sale (8,000,000). Thus, the ending inventory has an estimated value of 5,750,000.