Business and Personal Finance: What Goes into Inventory Costs?

The Inventory-Cost Connection: What Goes into Inventory Costs?

The whole point of your inventory is selling it. The point of selling it is to make some money. In order to actually make a profit by selling your inventory, you have to know how much it really costs to make every item so you can set your prices accordingly. Otherwise, you could actually lose money on every single product you sell.

For resale operations, such as retailers and wholesalers who buy and sell complete merchandise, figuring out that total cost is more involved than you may think. Manufacturers—companies that actually make the products from scratch—have a lot more math to do to get to their true inventory costs.

Total Product Costs for Retailers

In the retail trade, you get merchandise from your suppliers and sell it as-is to your customers. If it comes in a box, you sell it in the box; if it comes blue, you sell it blue. Your role in the product process is just to make your display look appealing enough to attract customers and get them to open up their wallets. Even with that tiny role in the product’s life, you still have a few numbers to add up to get to your total product cost.

At the base of this little calculation is the price you paid for the product.

Add on to that any sales tax you had to shell out, as well as any delivery charges you paid to get the product to you. If you got some kind of dis- count—for instance, for early payment of your invoice—deduct that from your inventory cost. Now, you’ve got the basic equation: Total inventory cost = total item price + sales tax + delivery charges − discounts.

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Once you have that overall total amount, divide it by the number of units you bought to get the per-unit cost.

So, suppose you bought 500 DVDs for $10 each—a total of $5,000. You paid 5 percent sales tax, which came to $250. It cost you $50 to have the DVDs delivered to your door. Finally, you paid the invoice within ten days, which got you a 2 percent discount on the original price, for a savings of $100. Your total inventory cost for these 500 DVDs comes to $5,200, calculated like this: $5,000 + $250 + $50 − $100. That makes your total unit cost $10.40 per DVD ($5,200 divided by 500 DVDs).

Product Costs for Manufacturers

When your company makes the products that it sells, figuring out the product costs is a little trickier than copying a few numbers from an invoice. First, you need to know exactly what went into making the product.

Second, you need to know how much you paid for each component that goes into your finished product. This part works the same way as it does for retail goods; you add up the item cost, the sales tax paid, and any delivery charges, and then subtract any discount you received. Divide that overall total by the number of units you received to get a unit cost for each component.

If you were just buying and selling finished goods, your job would be done there. Since you are creating new products out of the component parts, though, you have another couple of steps to tackle.

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