Now that you have your expense receipts organized and categorized, it's time to adjust inventory costs to calculate cost of goods sold. To follow is a definition of the different types of inventory and instructions on how to use inventory costs to calculate your arts and crafts business net income and taxable income.
Have you come in this series in the middle? Here's your guide to the first few pages in the series: the first article in this series discusses using an off-the-shelf accounting software program such as QuickBooks and using a spreadsheet program such as Excel, the second explains how to organize your expense receipts, the third goes over fixed assets, education expenses and meals and entertainment, the fourth discusses organizing travel and misc expenses.
Cost of Goods Sold
Cost of goods sold is the cost of the handcrafted items your arts and crafts company makes. Your company can either make the product entirely from raw materials or buy some of the components already made to integrate into your design.
Inventory, which I discuss on page three of this series of articles, does not automatically get deducted as an expense. You can only deduct your cost for buying inventory after it is incorporated into a product you have sold. This means you'll probably have three types of inventory: raw materials, work in process and finished goods.
Explaining the Different Types of Inventory
Here is an brief explanation of the different types of inventory. For a more blown out explanation see my article about the five types of inventory.
Everything you buy to make the product is classified as raw materials. Work in process includes all your arts and crafts raw materials that are in various stages of development. When your arts and crafts items are completely ready to sell at craft shows or other venues, they are finished goods.
When is the best time to take inventory? Well, December 31 or January 1 is optimum. But let's face it, I have better things to do on both days. So I either take inventory after my last holiday items are shipped to the customers or directly after the first of the year.
For the smaller arts and crafts business it's probably sufficient for you to do somewhat of a rough calculation on how much inventory is remaining in your company assets.If you use some type of program to track purchase/use of raw materials, you'll have a good inventory figure. Most artist and crafters don't since the amount of work needed to enter the items into the accounting system isn't worth the effort.
For raw materials, you probably have a good handle on how much the ones left in inventory cost. If not check out your vendor invoices. Then add up the cost of all raw materials remaining in inventory. This figure gets subtracted from your total inventory costs for the year (plus beginning inventory if you had any inventory at January 1).
So if your inventory on January 1 is $100 and you purchase $500 inventory during the year, your total inventory is $600 ($100 + $500). You add up the cost of inventory remaining and that total is $200. Your first figure for cost of goods sold is $400 ($600 - $200). Then you have to also adjust for work in process and finished goods.
Work in Process and Finished Goods
At year-end I have no work in process, as I don't have the time to start making new product after Thanksgiving that isn't going out the door to holiday customers by December 25. I rarely have finished goods inventory too for the same reason.
If you have either work in process or finished goods, calculate the cost of inventory in each and further subtract that from your cost of goods sold figure.
So, if you have $50 inventory cost in work in process and finished goods inventory, your ending inventory is $250 ($200 + $50). Subtract that figure from the $400 above to get a final figure for cost of goods sold of $350 ($600 - $250).
Quick and Dirty Cost of Goods Sold
If you have a standard mark-up for your arts and crafts products and carry little work in process or finished goods inventory, you could also just figure cost of goods sold using your mark- up.
It works like this:
- Gross Sales = $15,000
- You normally double the cost of raw materials used to set your sales price.
- Cost of Goods Sold = $7,500 ($15,000/2)
Additional Inventory and Cost of Goods Sold Resources
I've written some other articles you may find helpful:
The next article in this series gives you the low-down on the first step towards using your organized expense receipts to figure your bottom line.