An anonymous commenter asked us to confirm that inventory does not affect profit and loss statements, but does affect cash flow.
Inventory is product you buy to resell, so yes, it affects your cash flow. You spent money to purchase it. You collect money when you sell it.If you are preparing Cash Flow Statements, you’ll show inventory purchases as a cash outlay.
Inventory purchases are not a regular expense. The money you spend to purchase it does not go on your Profit and Loss Statement. (Want a refresher on the P&L? I explain more, in Do you get accounting?)
The total inventory you own is an asset, and it goes on your Balance Sheet.
Inventory also gets its very own financial calculation, Cost of Goods Sold. It represents the amount you paid for the items you sold. That gives you a good number to compare with your sales to see how much money you made. It’s usually figured once a year, and is a required section on your income tax return in the USA.
Here’s the formula to calculate it:
- Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold.
All those numbers will be the wholesale cost that you paid for your inventory items.
This calculation is one reason why you must count your inventory at the beginning of each year. You’ll need to know where you started in order to figure the cost of goods sold.
Special thanks to the anonymous commenter for suggesting this topic! What small business questions do you want answered? Ask away!
This article is part of the Small Biz 100, a series of 100 practical hands-on posts for small business people and solo entrepreneurs. If you have questions you’d like us to address in this series, leave a comment or send us an email at becky@smallbizsurvival.com. This is a community project!
Photo by Becky McCray.
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One good book that EVERY entrepreneur should read is “Finance for nonfinancial managers” By Robert Cooke.
Explains all the tough concepts of accounting with very easy examples.