An important deduction for small business owners is Cost of Goods Sold, which is calculated through the following formula:
Beginning Inventory + Inventory Purchases – End Inventory = Cost of Goods Sold
Your beginning inventory, plus the amount of inventory purchased over a given period — a month or a quarter — yields the total inventory available that could have been sold. This assumes that inventory not present at the end of the month or quarter has been sold.
Some units of inventory cost more than others as goods often go up in price. There are three commonly used methods of inventory valuation: FIFO, LIFO, and Average Cost.
First-In, First-Out (FIFO)
The “First-In, First-Out” (FIFO) method of calculating cost of goods sold assumes that the oldest units of inventory are sold first.
Last-In, First-Out (LIFO)
The opposite occurs when one uses the “Last-In, First-Out” (LIFO) method. LIFO assumes that the newestunits of inventory is sold before older items.
The average cost method takes the beginning inventory balance and additional purchases of inventory to determine an average cost per unit, which is then used to determine both the cost of goods sold and the ending inventory balance at the end of the period.
Calculating the Cost of Goods Sold is particularly important as April 15th approaches. If it turns out that you owe Uncle Sam but don’t have enough cash on hand to pay your tax bill, Biz2Credit can help.
John Schetelich A graduate of Seton Hall University with a degree in accounting, John Schetelich has been preparing income tax returns for small business owners for over 20 years.