Managing Inventory and Cost of Goods Sold (COGS) for Profitability

Why Inventory Accuracy Matters for Your Bottom Line

Inventory is more than just stock on a shelf—it represents a significant financial investment in your business. For e-commerce businesses, especially product-based retailers, accurate inventory tracking directly impacts profit margins, cash flow, tax reporting, and customer experience.If your inventory records are off, you could:

• Accidentally oversell stock you don’t actually have
• Miss out on sales due to under-reporting available inventory
• Reorder stock unnecessarily, tying up more money
• Misreport your profitability due to incorrect stock valuations

Accurate inventory tracking ensures you know:

• What you have in stock
• What it’s worth
• When to reorder
• Whether your product lines are actually profitable

It also affects your accounting—stock levels at the beginning and end of a financial year determine your Cost of Goods Sold (COGS), which in turn affects your gross profit and taxable income.

Understanding Cost of Goods Sold (COGS)

Cost of Goods Sold is an accounting term that refers to the direct costs associated with producing or purchasing the items you sell. For most e-commerce businesses, this means:

• The wholesale cost of inventory purchased for resale
• Shipping and freight costs (inbound)
• Import duties or customs fees
• Any costs directly incurred to bring the item to a saleable condition

COGS does not include:

• Advertising or marketing
• Website hosting or software
• Packaging (unless highly specific and product-related)
• General business overheads

The formula for calculating COGS in a retail business is:

Opening Inventory + Purchases – Closing Inventory = COGS

This formula assumes you're using a periodic inventory method, which many small businesses do. If you're using perpetual inventory tracking (as enabled by Xero and inventory apps), COGS is calculated in real time as each sale is made.Knowing your COGS allows you to:

• Calculate your gross profit (Sales – COGS)
• Identify underperforming products or low-margin items
• Make informed pricing decisions
• Prepare accurate tax and BAS lodgements

Overstated or understated COGS can lead to incorrect profit figures and tax issues. For example, failing to record closing stock at EOFY will inflate COGS and underreport profit.

Streamlining Inventory Management with Xero

Xero has built-in inventory tracking that allows you to manage stock levels and COGS directly. There are two approaches:

• Untracked Inventory: Quick and simple. You record purchases as expenses. You’ll need to adjust for closing stock manually at EOFY to calculate COGS accurately. Good for very small retailers or digital-only sellers.
• Tracked Inventory: More advanced. You enter purchase quantities and costs. When you sell an item, Xero deducts the stock and records COGS automatically. Ideal for physical product sellers.

When using tracked inventory in Xero:

• Products are valued using FIFO (First In, First Out)
• Xero creates journal entries to transfer costs from inventory to COGS
• You can see real-time inventory value on your balance sheet

This keeps your profit and loss statement up to date and gives you better financial oversight.If your e-commerce store uses platforms like Shopify, WooCommerce, or BigCommerce, you can integrate them with Xero using tools like:

• Unleashed or DEAR/Cin7 Core – advanced inventory management systems with Xero sync
• A2X, Amaka, or Link My Books – summarise daily/weekly sales and push them into Xero
• Synder or Dext Commerce – handle multichannel sales (eBay, Amazon, Etsy)

These tools ensure inventory movements, sales, and costs are properly recorded in your accounting system, minimising manual errors.

Common Inventory Mistakes and How to Avoid Them

Here are some of the most common inventory pitfalls e-commerce business owners encounter:1. Not doing regular stocktakes ▶ Solution: Schedule monthly or quarterly cycle counts and reconcile to Xero.2. Not adjusting for damaged, lost, or stolen items ▶ Solution: Use inventory adjustments in Xero or your app to write off discrepancies.3. Recording purchases as expenses without accounting for stock on hand ▶ Solution: Move to tracked inventory or ensure year-end stocktake is accurately recorded.4. Using inconsistent COGS calculations ▶ Solution: Stick with one method (usually FIFO or average cost) and document your process.5. Not integrating inventory with your e-commerce platform ▶ Solution: Use tools that sync sales/orders to Xero and update stock levels automatically.6. Over-ordering stock without cash flow planning ▶ Solution: Use sales history reports to forecast seasonal trends and reorder points.Avoiding these issues leads to clearer financials, better decisions, and smoother operations.

Final Word

Whether you’re just starting out or managing a high-volume e-commerce store, proper inventory and COGS tracking is essential. It gives you insight into profitability, helps with tax compliance, and supports better pricing and purchasing decisions.If you’re unsure whether your inventory is set up properly in Xero—or if you’d like support integrating your systems for real-time, accurate reporting—contact Books Bean Kept. We’ll help you get it right the first time.

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