The retail inventory method would include which of the following in the calculation

The retail inventory method is an accounting approach used to estimate the value of your store’s ending inventory for a specific time period.

Doing physical inventory counts is time-consuming, and can be disruptive to business operations if it requires you to close your shop. The retail inventory method (RIM) is an alternative solution that lets you estimate how much stock is remaining during a given period, using a simple calculation. 

You probably have a lot of cash invested in stock, which makes sense, as buying inventory is essential to any retailer. That’s why it’s important to monitor your inventory so you can choose wisely when it comes to ordering stock, carrying more products, and deciding what types of merchandise you should invest in to increase sales. 

There are many ways to keep a pulse on the value of your inventory, but the retail inventory method is one of the fastest and most cost-efficient ways to do it on a monthly basis. 

In this article, you’ll learn more about RIM, how to run the calculation, and the types of businesses that benefit most from using the retail inventory method.

Table of Contents

• What is the retail inventory method?
• How to calculate ending inventory with the retail inventory method
• Example of the retail inventory method
• Advantages and disadvantages of the retail inventory method
• Who should use the retail inventory method?

What is the retail inventory method?

The retail inventory method calculates the value of your inventory over time.  It measures the cost of your inventory in relation to the retail price of the products and uses the cost-to-retail ratio. 

While it’s a quick way to count inventory, it’s not 100% accurate. Physical inventory counts or cycle counts should still be part of your inventory management strategy to ensure your year-end financial statements are correct. 

How to calculate ending inventory with the retail inventory method

1. Calculate your cost-to-retail ratio
2. Calculate the cost of goods available for sale
3. Calculate your cost of sales
4. Calculate ending inventory

Follow these steps to use the retail inventory method to calculate your monthly ending inventory.

Cost-to-retail ratio

Calculate your cost-to-retail ratio by dividing your cost by the retail price and multiplying it by 100 for the percentage.

Cost-to-retail ratio = cost / retail price x 100

Cost of goods available for sale

Calculate the cost of goods available for sale by adding your cost of purchases to your beginning inventory cost. 

Cost of goods available for sale = beginning inventory cost + cost of purchases

Cost of sales

Calculate your cost of sales by adding up all your sales and then multiplying the total by your cost-to-retail ratio.

Cost of sales = sales x cost-to-retail ratio

Ending inventory

Calculate ending inventory by subtracting the cost of sales from the cost of goods available for sale. 

Ending inventory = cost of goods available for sale – cost of sales

💡 PRO TIP: With Shopify POS, you can skip the manual calculations and see your inventory cost, ending quantity, and total value for each month. To get started, view the Month-end inventory snapshot report in Shopify admin.

Example of the retail inventory method

Let’s take a look at a hypothetical example of the retail inventory method calculation: 

If a skincare retailer sells face cream for $25 and purchases each bottle for $5, the cost-to-retail ratio would be 20%. 

20% cost-to-retail ratio = $5 cost / $25 retail price x 100

Let’s say the retailer’s beginning at-cost inventory was $5,000 (1,000 units = $5000 / $5), and it purchased $2,500 (500 units = $2500 / $5) worth of additional inventory during the month for a total of $7500 (1,500 units). In the same period, it sold $10,000 worth of products (400 units = $10,000 / $25).

Here’s how we can calculate its ending inventory cost using the retail inventory method:

($5,000 + $2,500) - $2,000 = $5,500

Using this calculation, you can measure your ending inventory cost and also estimate your physical inventory counts. If you divide the ending inventory cost ($5,500) by the cost per unit of face cream ($5), we can assume there are 1,100 bottles left of the total 1,500 units that were purchased throughout the month. 

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Assuming there were no at-cost or mark-up changes during the month, this calculation would provide a good level of accuracy.

Advantages and disadvantages of the retail inventory method 

The main advantage of the retail inventory method is saving time on doing physical inventory counts. The disadvantage is that, depending on certain variables, it’s not always the most accurate technique. Let’s take a closer look:

Advantages of RIM

When Malcolm McNair, a Harvard Business School professor, invented the retail inventory method in the early 1900s, he aimed to make tracking inventory and bookkeeping less time-consuming and more cost-effective. 

RIM was created with three main goals in mind, which today translate into the benefits of using the retail inventory method: 

• Simplified inventory counts. RIM lets you count your stock at any time, without having to close your doors to do physical counts or spend much time reviewing invoices and purchases. 
• Practical for all retailers. RIM is a practical method that you can use no matter the size or type of retail business you have. You don’t need to be an expert at inventory management or accounting to get it right.
• Requires less time and labor costs. RIM is quick and efficient, so you and your staff can spend more time on building relationships with customers and selling. It can also help you save on extra costs that could arise if your staff has to work long hours counting inventory. 

Disadvantages of RIM

As with any solution, you should also consider the drawbacks of the retail inventory method:

• It’s only an estimate. RIM is calculated based on assumptions, and does not have the same level of accuracy as physical inventory counts. If you’re not meticulous about your accounting, using the retail inventory method could lead to unreliable calculations. 
• It’s not a good solution if you have inconsistent markups. RIM works best if you have the same markup across all your products. If this is not the case, the true ending inventory cost may not be represented accurately. Also, if the markup on any given product changes during the current period (for example, if you have a sale), the calculation will be wrong. 
• You still have to do physical inventory counts. While RIM can help you count inventory on a monthly basis, it’s still important to do physical inventory counts once or twice a year to ensure accuracy. 

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Who should use the retail inventory method?

• Multi-location retailers
• Retailers with warehouses
• Retailers that use markups consistently
• Retailers that don’t run a lot of sales
• Wholesalers with large volumes of similar products

There are many types of businesses that can benefit from using RIM to calculate ending inventory, including the following:

Multi-location retailers

If you have many store locations, RIM is a great way to get a quick overview of your inventory across all locations without having to manually count each stock unit and potentially disrupt business operations. 

Retailers with warehouses

Using the retail inventory method to calculate stock you have in a warehouse saves you the hassle of going to the warehouse to count it (or spending money to have the warehouse employees count it). Also, the cost of merchandise in your warehouse is usually consistent—there are no sales or price cuts like you have in-store—which leads to more accurate results with the RIM calculation. 

Retailers that use markups consistently

If your products consistently have the same cost-to-retail ratio, meaning your product markups are mostly the same across all your merchandise, the retail inventory method is a reliable solution. But if you sell a range of products that have varying markups, RIM may not be the best inventory management approach for your business.

Retailers that don’t run a lot of sales 

If you operate your retail business on a model where there are few to no sales promotions, the retail inventory method is a great option, since you don’t run the risk of discrepancies due to inconsistent markups.

Wholesalers with large volumes of similar products

If you sell your products to other retailers in large quantities and all the items have the same or a similar markup, the retail inventory method is a great way to reduce the time spent on physical inventory counts. 

Is RIM right for your store?

The retail inventory method is time-saving and cost-effective, but it’s not flawless. This approach works best when it’s part of your overall inventory management strategy. Use RIM in tandem with other techniques like a powerful retail management system or POS, physical inventory or cycle counts, and consistently reviewing your sales performance and stock.

Manage inventory from one back office

Shopify POS comes with tools to help you manage warehouse and store inventory in one place. Forecast demand, set low stock alerts, create purchase orders, know which items are selling or sitting on shelves, count inventory, and more.

What is the retail inventory method?

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