The Art of Inventory Costing for Specialty Food Brands
For Specialty Food Brands, proper inventory costing can be the difference between a flaky profit crust on top or a financial soggy bottom. It plays a pivotal role in your overall inventory management, and understanding its core concepts will allow you to make informed decisions.
If you read “inventory costing” and assumed you were about to be served a big bowl of word salad, don’t worry! The friendly accounting nerds at BGG have you covered with an easy-to-understand breakdown of the art of inventory costing. We’ll explain what it is, common methods and best practices, and the real-world benefits that inventory costing can provide for your business.
Let’s get started!
What is Inventory Costing?
Quite simply, inventory costing is the process of assigning a value to the items you have in stock. Think of your aged prosciutto and gourmet cheese wheels as ingredients in a financial souffle. Inventory costing helps you measure the precise amounts (values) of these ingredients so your business stays tall and delicious instead of collapsing.
However, inventory costing isn’t just about counting your stock and adding the dollar amounts together; it's about determining how much each of these items truly cost your business over time and how much that directly impacts your profitability and financial statements.
What Makes Inventory Costing So Essential?
Inventory costing holds a pivotal role in the financial success of Specialty Food Brands. More than merely an administrative task, it can profoundly impact your bottom line and the overall financial health of your business.
First and foremost, accurate inventory costing is fundamental for precise financial reporting. Understanding your actual Cost of Goods Sold (COGS) is essential for producing accurate financial statements, including your income statements and balance sheets. These documents are essential for making informed financial decisions, attracting potential investors, and demonstrating fiscal responsibility to stakeholders.
Inventory costing also directly influences your pricing strategies — since knowing the true cost of your products enables you to set competitive prices while maintaining healthy profit margins. Overpricing can (and usually will) deter customers, while underpricing can (and almost always will) lead to financial losses.
Effective inventory costing helps strike the right balance, enhancing your profitability and competitiveness in the marketplace.
On the flip side, ineffective inventory costing can lead to costly operational challenges. Overestimating your inventory costs can result in higher tax liabilities in the short-term and inflated operating expenses over the long-term, while underestimating them can lead to unforeseen financial setbacks. Accurate costing allows for better management of your cash flow.
Common Methods of Inventory Costing
Specialty Food Brands often have unique inventory management needs. When it comes to inventory costing, several common methods can be applied to determine your COGS.
Let’s quickly break down both methods before going into more detail for those aspiring number nerds in the class:
FIFO (First-In, First-Out)
How it Works: FIFO uses the cost of your earliest acquired items first
Pros: Reflects the natural flow of inventory for perishable items
Cons: Might inflate profits during inflation
LIFO (Last-In, First-Out)
How it Works: LIFO uses the cost of your latest acquired items first
Pros: Might lower taxes during inflation
Cons: Can distort inventory value and not ideal for perishable items
As you can see, both methods have their uses, but also their fair share of difficulties.
Under the FIFO method, it’s assumed that the first items added to your inventory are the first to be sold. In the context of Specialty Food Brands, this means that the oldest jars of artisanal jam are the ones you sell first.
Then there’s the LIFO method, which assumes that the most recently added items are the first to be sold. This is far less common in the Specialty Food industry for obvious, perishable reasons. However LIFO can be applicable in certain scenarios, like when recent inventory items are tied to upcoming holidays or more representative of current market conditions.
Best Practices for Proper Inventory Costing
To excel in the art of inventory costing, Boutique Wineries and Specialty Food Brands need to adopt a few key practices.
Accurate Record-Keeping is the foundation of precise inventory costing. Strive to maintain comprehensive records of inventory purchases, including invoices, shipping costs, and any other associated expenses. By maintaining quality documentation, you can make sure that your inventory cost calculations are based on actual expenditures rather than best guesses.
Regular Reconciliation of your physical inventory with your recorded inventory is also essential. This fancy little “self-audit” helps identify discrepancies, reduce errors, and safeguard against inventory shrinkage. It's a good proactive measure for maintaining the integrity of your inventory and keeping it in line with your financial records.
Incorporating Technology into your inventory management practices streamlines your costing process, automates calculations, and provides real-time insights into your inventory costs. These tools not only save you time, but also minimize the chances of manual errors.
Ongoing Practice of good inventory costing is essential to continued success. Rather than treating it as a one-time task, you should regularly revisit and update your costing method and practices to adapt to changing market conditions, fluctuations in prices, and shifts in your business needs.
Pro Tip: Consistency is paramount - select an inventory costing method that aligns with your business needs and maintain it consistently over time. Consistency not only ensures accurate financial reporting but also simplifies decision-making.
The Real-World Impact of Inventory Costing
Now that we all have a much better understanding of inventory costing, let’s look at some real world examples of the lessons we learned in action!
Please Note: Certain names and locations have been changed to protect the reputations of the fictional people involved with these cases.
Toasting to Sweet Success: An Oregon Winery's Journey
Nestled between the scenic foothills of Oregon, The Grape Escape: Winery and Escape Rooms was pouring its heart and soul into crafting the next generation of exceptional blends. But something sour lurked in their financial cellar...
Sure, they were consistently selling out their vintages, and yet for some reason their profits didn't mirror the demand. A careful look at their inventory costing revealed they were using a mixed approach, causing confusion in pricing. They were underpricing their flagship wines, leaving profits on the table.
By tracking the costs of the premier bottles they chose for their flagship wine, The Grape Escape was able to align their prices with the elevated costs to produce their most popular wines. They were able to adjust their prices, uncorking a 15% increase in profits and finally finding balance in their financial statements.
A Savory Solution: The California Cheese Maker's Tale
Cheddar, She Wrote was a specialty cheese maker at the top of its game, lighting the gourmet food world on fire with its new wheels. Unfortunately, the financial side of the business was not as smooth as their renowned brie...
They were not regularly counting their physical inventory because they felt they were just too busy. This led to a distorted and downright incorrect view of their inventory.
A friend recommended they talk with the accounting experts at BBG, and we were able to give them simple step-by-step guides to complete an efficient physical inventory count. Harvesting the low-hanging fruit led to more accurate financial reporting and reduced their working capital financing requirement by 20% which put more cheddar in their pockets!
Looking for more advice on inventory costing? In the market for an experienced bookkeeping partner? Contact BBG today! We’d love to help you meet your financial and personal goals for your business.
