Tracking inventory properly means more than knowing what sold. You need accurate records of what came in, what went out, what came back, and what disappeared. Get this right and you know your actual profit margins. Get it wrong and you’re guessing at profitability while paying taxes on phantom income.

Start with purchases. Every inventory purchase gets recorded at cost, not retail price. When a shipment arrives, verify quantities against the invoice and enter it into your system. Keep those invoices organized because they document your inventory cost basis. If you buy the same product at different prices throughout the year, you need a consistent method for determining which cost applies when you sell it. Most retail shops use average cost, which QuickBooks handles automatically.

Cost of goods sold is the calculation that determines your gross profit. The basic formula is beginning inventory plus purchases minus ending inventory equals COGS. Your accounting software tracks this continuously if you’re using perpetual inventory, or you calculate it at period end with physical counts if you’re using periodic inventory. Either way, the accuracy of your COGS depends entirely on accurate purchase records and ending inventory counts.

Customer returns affect your inventory and COGS. When someone returns a product, that item goes back into inventory and the COGS for that sale gets reversed. If you’re just recording refunds as negative sales without adjusting inventory, your numbers drift further from reality with every return. Products returned in damaged or unsellable condition need to be written off rather than added back to sellable inventory.

Vendor credits and returns to suppliers also need proper recording. When you return damaged goods to a vendor or receive a credit for a pricing dispute, your inventory cost changes. A $500 credit from a vendor reduces what you paid for that inventory. If you don’t record it, your COGS is overstated and your gross margin looks worse than it actually is. Track these credits when you receive them, not months later when you finally reconcile statements.

Shrinkage is the inventory that vanishes between purchases and sales. Theft, damage, spoilage, and administrative errors all contribute. You won’t see shrinkage in your transaction records because there’s no transaction. It only shows up when you count what’s physically on shelves and compare it to what your system says you should have. Most retail shops experience 1 to 2 percent shrinkage annually. Higher than that suggests a problem worth investigating.

Physical inventory counts are not optional. Your system thinks you have certain quantities based on recorded purchases and sales. Reality may differ. Conduct full counts at least quarterly. Monthly cycle counts of high-value or high-velocity items catch problems faster. When counts don’t match system quantities, investigate the variance before adjusting. Consistent discrepancies in the same products point to either theft or receiving errors worth fixing.

Inventory accounting done properly gives you actual gross margins by product category, identifies slow-moving stock tying up cash, and produces accurate COGS for your tax return. Done poorly, you’re operating on bad information and potentially overpaying or underpaying taxes.

The implementation matters as much as understanding the concepts. Your point of sale system should integrate with your accounting software so sales automatically reduce inventory. Receiving should happen in the system when product arrives, not whenever someone gets around to it. Returns should be processed immediately with proper categorization. If you’re running all this on spreadsheets or disconnected systems, errors multiply.

Many retail owners in The Woodlands and the Greater Houston area find that small business bookkeeping and tax services pay for themselves by catching inventory problems, maintaining accurate COGS records, and preventing the year-end scramble of trying to reconstruct what actually happened with stock throughout the year.