Inventory on the books: COGS, counts, and write-downs

When you buy inventory, you haven't spent money in the way your gut thinks you have. You've traded one asset (cash) for another (goods on a shelf). That distinction sounds academic until it quietly distorts your profit, your taxes, and every margin number you use to make decisions. Getting inventory onto the books correctly is one of the highest-leverage things a product business can fix.

Here's the core idea. Inventory is an asset—cash parked on a shelf—and it stays on your balance sheet at cost until it sells. The moment it sells, that cost moves to your income statement (your P&L, the report showing revenue minus expenses) as COGS, or cost of goods sold. This is the matching principle: you recognize the cost of a product in the same period you recognize the revenue from selling it, so each sale shows its true profit.

When that mechanism runs sloppily, the damage is invisible until it isn't. Your gross margin looks fine on the dashboard while the real numbers underneath have drifted somewhere else entirely.

How a purchase becomes an expense

Say you buy $10,000 of goods this month. Nothing hits your P&L yet—you've simply converted $10,000 of cash into $10,000 of inventory on the balance sheet. Your expenses for the month don't move, and neither does your profit.

Now you sell half of those goods this month. The cost of what you sold—$5,000—moves out of inventory and lands on the P&L as COGS. The other $5,000 stays on the balance sheet as inventory still waiting to sell. If those goods sold for $9,000, your gross profit on them is $9,000 minus $5,000, or $4,000. Spend the whole $10,000 as an expense up front, and you'd report a fake loss this month and fake profit next month. The timing is the whole point.

Counting what's actually there

Your books say you have a certain quantity on hand. Reality often disagrees. Stock gets damaged, miscounted at receiving, returned and never logged, or quietly walks out the door. The gap between what your records claim and what you physically have is called shrinkage, and the only way to find it is to count.

A physical count means someone walks the shelves, counts the units, and reconciles that number against the books. When the count is lower than the records, you book the difference as an expense and your inventory asset drops to match reality. How often you count depends on your volume and risk:

• A full annual count at minimum, ideally tied to your year-end close.
• Cycle counts—small, rolling counts of a subset of items—monthly or quarterly so errors surface fast.
• Tighter, more frequent counts on high-value or theft-prone items where a small miscount means real dollars.

Writing down what won't sell

Some inventory stops being worth what you paid. It's obsolete, expired, damaged, or simply unsellable at anything near cost. Accounting calls for a write-down: you reduce that inventory's carrying value to what you can realistically recover and record the drop as an expense now.

Skipping this feels harmless, but it lies twice. Carrying dead stock at full cost overstates your assets on the balance sheet—you look richer than you are. And because the loss never hit COGS, it overstates your profit too. You end up paying tax on earnings you didn't make and steering by a margin number that's pure fiction. If your COGS is understated because unsellable goods are still sitting in inventory, your gross margin looks healthier than the business actually is—exactly when you most need the truth.

Costing methods, kept simple

When you buy the same item at different prices over time, you need a rule for which cost moves to COGS on each sale. The two common ones are FIFO (first in, first out), which assumes your oldest-cost units sell first, and weighted average, which blends all your unit costs into one running average. Both are accepted; the choice mainly affects how COGS and ending inventory split when prices are moving.

You don't need to master the mechanics—your bookkeeper or accounting software handles them. What matters is that you pick one method, apply it consistently, and understand that switching methods changes your reported profit. Consistency is what makes your margins comparable from month to month.

Start with one move this quarter: schedule a physical count, reconcile it against your books, and write down anything that won't sell. You'll trade a comforting fiction for a margin number you can actually trust.