How to implement retail inventory method in your business

Retail inventory management is often termed the ‘invisible hand’ of business.

Your customers don’t see it, but it guarantees your products are always on the shelves at the right price.

And yet, many businesses have no process to actively monitor their inventory or know how much it’s worth.

The result is that small businesses are losing ground on their profit margins to more efficiently-run enterprises.

Luckily, working out optimal retail pricing isn’t too difficult if you have a strategy in place.

Welcome to the retail inventory method, where we explain how you can easily calculate the total value of your products.

Understanding retail financial models

For a business to accurately price its products, it needs to keep on top of its retail inventory management checklist.

Once you have this bird’s-eye oversight, you can apply different types of pricing calculation methods, such as:

• The Retail Inventory Method: This approach estimates ending inventory by considering the cost-to-retail ratio, i.e. selling every item at the best possible ‘market price’.
• FIFO (First-In-First-Out): This method assumes that the first items you buy are the first ones you sell. i.e. keeping prices low so that new stock can be sold quickly — such as with takeaway services that sell food with short expiration dates.
• LIFO (Last-In-First-Out): LIFO assumes the opposite, i.e. lowering prices on older stock to clear out warehouse space as quickly as possible.

Benefits and limitations: when to use it

The retail inventory method is often favored due to its simplicity. For most businesses, it’s the ideal pricing method to use during standard market conditions.

But let’s explore the benefits and limitations of such a strategy to help you decide the best time to use it.

Benefits:

• Saves time: The Retail Inventory Method offers a quick snapshot of your inventory’s value, saving you time and effort compared to physically counting each item.
• Helps you manage your warehouse: When mark-up prices between your products are steady, the model is great for tracking total inventory value.
• Keeps prices consistent between stores: This model can be applied anywhere and helps keep prices uniform wherever your customers shop — no matter if it’s in the middle of Tokyo or on a .ae domain.
• It’s versatile across industries: Whether you’re managing legal research materials or t-shirt printing, the retail inventory method can be a valuable tool for estimating inventory value.

Limitations:

• Sometimes inaccurate: Obviously, the model won’t be as accurate as physically counting every item in your warehouse.
• Not ideal for seasonal sales: Many businesses offer promotions during the holiday period, so the model won’t apply as accurately during these times.

The retail inventory method works as an estimation of product value, and shouldn’t produce any unpredictable effects on stock levels.

However, it can be a lengthy process to calculate, and you won’t get the same results as inventory management software. 

Step-by-step guide: how to implement the retail inventory method

Calculate your cost-to-retail ratio

To begin using the retail inventory method, you need to calculate your cost-to-retail ratio.

This involves dividing the cost of your inventory by the retail price and multiplying by 100 to get the percentage.

Determine cost of goods available for sale

Calculate the total value of goods you have for sale by adding what you already had to what you bought. This gives you an idea of the value of all the remaining products you could potentially sell. 

Calculate your cost of sales

Now, you must calculate your cost of sales by multiplying your total sales during the period by the cost-to-retail percentage.

This helps you see how much you’ve spent to make the sales happen. 

Calculate ending inventory

The final step is to calculate your ending inventory.

To do this, subtract the calculated cost of sales from the cost of goods available for sale.

The number you get will be a rough estimate of your total remaining inventory value.

Example calculation

Let’s illustrate how this pricing model works in practice. In this case, imagine you’re a retailer that sells products used by law firms, or for inbound marketing for lawyers:

1. You have a beginning inventory of legal research materials worth $8,000.
2. During the month, you purchased additional materials for $3,000.
3. Your total cost of goods available for sale is $11,000.
4. Considering your consistent mark-up of 40%, your cost of sales would be $6,000 (40% of $15,000 in total sales).
5. Subtracting the cost of sales from the cost of goods available gives you an ending inventory value of $5,000.

From here, you could adapt your inventory levels and price points according to projections of expected future demand.

Leverage digital tools

In short, shrewd inventory handling is crucial if you’re to prevent stock wastage and keep products available at consistent prices.

To do this, you must adopt an inventory pricing model that does some of the legwork for you — after all, most businesses can’t do manual stock checks before every new order.

Luckily, the retail inventory method provides a pretty good estimation of your total inventory value, a necessity in fast-moving businesses.

Or, even better, you could leverage digital tools to get one leg up on your competitors.

Our business management software does a great job of handling your inventory and supply chain needs.

Why not check it out and see how MYOB can maximise your business’s efficiency?