How should I record my COGS in my books?

Tracking cost of goods sold (COGS) and inventory is one of the most common pain points felt by many of you as DTC brand owners.

In order to help relieve some of this pain for you, with Finaloop, you can choose to maintain your COGS and inventory in the way that works best for you and your online business.

You have 2 options to record your COGS with Finaloop:

1. Purchase-based COGS - Your COGS are based on your purchases of inventory-related items.
2. Sales-based COGS - Your COGS are the actual cost of the products you sold, based on your input.

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We'll make sure your COGS are properly synced to your financials based on your chosen method.

Let's quickly run through the pros and cons of each option so you can choose which makes more sense for you and your business.

Which method should I use to record my ecommerce COGS?

1. Purchase-based COGS

Under this method, each of your inventory purchases is categorized directly into the relevant account under cost of goods sold in your P&L (i.e., COGS, Packaging or supplies, or Shipping-in). With this method, you don't maintain an inventory balance on your balance sheet.

Typical user that uses purchase-based COGS: Smaller businesses that hold a low value of inventory each month relative to their sales and doesn't have the resources to properly track COGS on a consistent basis.

Pros

• Easier to manage - the only input we need from you each month is with respect to any uncategorized transactions as this can impact your COGS for the month. Everything else is done automatically by Finaloop. 
• Real-time P&L - Your P&L is updated real-time since we're not waiting on input from you at month-end regarding your actual COGS.

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Cons

• Less accurate - Without tracking your actual costs and inventory, you don't have an accurate view of your financial health. For example, if you purchase all of your inventory in one month, that month would appear to have been significantly less profitable than all other months. 
• Less visibility into costs - If you don't understand how much your sales actually cost you and how much inventory you have left, you won't know when to reorder or how to better manage your costs.

2. Sales-based COGS

Under this method, we would provide you access to your inventory tracker tool. Each month, your inventory-related purchases are categorized to an inventory asset account on your balance sheet. Your monthly COGS are based on your inputs provided in the inventory tracker tool and are reflected in your P&L and balance sheet. 

Using this method, your P&L would not include real-time COGS and would, thus, be inaccurate until you update the tool for each month. 

Typical user that uses sales-based COGS: Larger companies with significant inventory balances at the end of the month or smaller companies that want better insight into their costs.

We generally recommend using the sales-based COGS if your unsold inventory balance at the end of each month is:

• Higher than 1% of your sales, OR
• Greater than $5,000. 

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Pros 

• Better accuracy - COGS in your books each more are more accurate and reflect actual sales
• Better visibility into costs - You get a more insightful gross profit each month help you better manage costs and analyze the health of your business

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Cons

• More complex - In order to input the correct numbers, you need to properly track COGS using an internal excel or an inventory management system. 
• Delayed P&L results - Until you input your COGS each month, your P&L would be incomplete.

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If you're interested in the sales-based COGS and want to understand more about tracking your inventory costs for your books, check out this blog.

A quick note on cash and accrual inventory tracking for your taxes....

In most cases, if you earn income by selling inventory, COGS must be deducted based on sales-based COGS, i.e., accrual basis. With certain exceptions, this rule applies whether you file taxes on a cash basis or an accrual basis.

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In other words, even if you file your tax return on a cash basis, your COGS deduction would generally be calculated based on the sales-based COGS, not purchase-based COGS. 

In recent years, tax laws were changed to allow for exceptions for certain inventory-based businesses. One of these exceptions allows you to deduct COGS based on purchases (pure cash basis) if you meet certain conditions, including: (1) you made a special tax election to report inventory on a cash-basis, and (2) you don't actively record the value of your inventory (although inventory count is OK).

To prevent any issues in qualifying for this exception, please confirm with your CPA if an election was made to report inventory on a cash basis under Treas. Reg. §1.471-1(b). If yes, choose the purchase-based COGS to record COGS each month. 

If no election was made, whether you file your taxes on a cash basis or an accrual basis, you can still choose to apply either of the methods in your books throughout the year. We will make sure to make any relevant adjustments at year-end to get your numbers tax-ready.