Inventory, oh Inventory!
Alexia, Brooke, Karina and many others have asked:
"What is included in inventory? Is Inventory just my finished jewelry? Do I include metals and gemstones that haven't been made into anything too?"
Short answer: yes, include the following:
- Raw Materials available for production
- Works in Process not yet ready for sale
- Finished Goods available for sale
The goal is to know the Inventory Value for each of these three categories.
From the 10,000 foot arial view in the sky:
Inventory Value is the cost of labor + materials.
But, we have to get realistic and into the nitty gritty of what this means. We can't operate at a sky high view, so let's land this plane and get in the warehouse and see what we actually have.
In each of our three categories: Raw Materials, WIP, Finished Goods, there are multiple things to look at.
- RAW MATERIALS can be made up of:
- unused findings
- unfinished chains (by the foot perhaps)
- casting grain
- Gemstones (unset)
- colored gems
- Raw Materials have not yet been worked and are exactly in the same condition as they were when purchased.
- No Labor is included in these costs (outside of milling fees paid directly to the original supplier). Milling fees are part of the original cost of the material.
- WORKS IN PROCESS are goods that are being made, but not yet ready for sale and include:
- Raw Materials, plus
- Labor starts to come in the picture here.
- Labor only includes outside labor you pay others for production or yourself if you are on payroll.
- Why? you ask why your labor is not part of the cost of your inventory. Well, if you are a Sole Proprietor or single member LLC and not required by law to be on payroll (ie paying payroll taxes) and are not on payroll, then your labor is Never part of the equation.
- When production labor is being paid for on payroll and FICA (aka Payroll Taxes: Medicare and Social Security) are being taken out, then this labor is considered part of the good. However, if you are not paying yourself (or if you are only taking Owner's Draws), then you are not paying payroll taxes and therefore, cannot claim your hourly labor cost as part of the cost of the good because you are not Actually paying it.
- Therefore, if you are on payroll, or are an S-corp, or corp required to pay payroll, AND you are separating out your admin work hours from production, then that production labor can be part of the product cost.
- If you are paying others for their production "bench" labor, whether they are on payroll or not (when they are responsible for their own self-employement taxes and you are not responsible for withholding them), this labor paid out is included in the cost of the good.
- FINISHED GOODS are completed products ready for sale and include:
- Raw Materials, plus
- Labor (as described above)
Value: Lower of Cost or Market
Here we need to determine if the price you paid for it is still the market price or if the price has decreased. In the jewelry industry, because metals are a commodity, and diamond prices set by Rapaport, it's best to keep an eye on the market. You may have bought gold when it was low, but it went even lower.
This loss on your purchase price is part of the loss of your inventory.
Kitco spot prices are based on unmilled, pure karat / non-alloyed metals. This is great to keep an eye on for the overall picture of what you're buying and selling. However, the metals you're likely buying are .925 Sterling Silver, 14 or 18 karat gold and they have also been milled into the wire or sheet you need. Therefore, it's best to run an order quote for your materials to see what the current price is if you were to replace what you have on hand.
The option is to record your inventory at the cost you purchased it, or at the cost it is currently (year end when you are confirming your physical inventory). If there is a loss, then that loss is recorded in the year it is incurred. It there is a gain, keep the price at the cost you paid for it. You aren't going to record an increase on inventory value; this will instead be a profit if the market price is still up when it sells. We like those!
Alternatively, if you aren't recording the Lower of Cost or Market and simply have the cost of what you paid, then when you sell it and if the market is lower, then you will not be able to make as high of a profit as when you bought it. This means you will have less money in your pocket. You will have a lower profit between the price of the sale compared to the price you paid.
What is Inventory Asset and what is Cost of Goods Sold?
When you buy metal and gems as raw materials, or finished goods that you plan to resell, these items are now an asset that you can liquidate. When you take those raw materials and make them into a finished good, it is still an Inventory Asset that you have on hand.
Products are always inventory ASSETS until they sell.
When products sell, the cost of that product now comes out of Inventory Asset and becomes a cost of goods sold to offset the revenue earned from the sale.
On the Profit & Loss Report (aka Income Statement) you will see:
The Inventory is sitting over on the Balance Sheet, another report that goes hand in hand with the Income Statement. On the Balance Sheet you will see the things you own and owe, so the Inventory Asset is sitting with your bank accounts showing what you Own. Only when it sells does the cost move out (decrease the value) of inventory on the Balance Sheet and into (increase the value) Cost of Goods Sold on the Income Statement.
What about my Wholesale Cost as the Inventory Cost?
No, wild child! Calm down, it is not the same.
Wholesale markup is your markup over the cost of producing the goods; this is considered Sales Income (aka Revenue).
When you sell at Wholesale, you are opting out of receiving full Retail value in exchange for your goods. You are lowering your profit margin for the opportunity to sell more because you are not having to cover the overhead of the stores you are selling to. They are bringing the foot traffic and paying for the store to sell your goods in them. The more wholesalers you have, the more goods you can sell and you just have to maintain the relationship with your wholesalers. This is why the markup from Cost of Goods to Wholesale is lower than Retail, but it is not your cost. Your Inventory cost is what you paid for the goods. Your Wholesale cost is what a reseller pays you for those goods. (and it better not be your cost or I'll get mad at you!)
Is it better to have more or less Inventory at the end of the year?
Inventory rolls. If you are tracking your inventory appropriately (perpetually or periodically), and your corresponding income and all of your overhead and operating expenses, then you can make informed decisions throughout the year regarding liquidating inventory. It is always better to order as needed. The less inventory on hand, means more money coming in because you've sold it.
Because inventory asset doesn't get (shouldn't be) expensed until it is actually sold, then it doesn't really matter to have more or less at the end of the year.
If you have more inventory at the end of this year, then you have that much more that can be sold and therefore expensed next year.
Let's say you want to get rid of inventory, so you have a sale. You are able to expense that inventory into cost of goods sold, but the profit is lower because you aren't selling it at the full retail price. This is a variable situation, but it is often best to sell inventory as fast as possible because while jewelry doesn't spoil, like food, it can age in style and markets do change.
Sell, baby, sell! At the end of the day, I don't want you to be a hoarder unless the market is low and then you should sit on your gold until it goes back up. It always does.