Introduction

Units of measure, or UOM, is important to consider because we need to decide what inventory valuation we’re talking about. For instance, if I say sales, am I referring to the units, the cost which I paid, or the retail the customer paid?

I will be referring to the monetary valuation of inventory using the United States Dollar, or USD, but you can replace that with any currency.  The following valuations are the most typical:

  • Units or Weight
  • Cost
  • Wholesale
  • Retail
  • Full Price or MSRP

In planning, particularly merchandise planning, these equations are invaluable.  Most planning tools are dimensional: product, location, and time, being the most popular. Without these balance equations, it would be very difficult to make the entire dimensional cube calculate correctly.

For each UOM I will introduce the most typical measures that add to the inventory or reduce the inventory.  Below is a summary of each equation equaling the ending on hand, or EOH.

Units or Weight

Units (UNT).  Refers to individual, or physically measurable components like units, weight or volume.  12, 6-pack AA batteries, 12 men’s mesh t-shirts and 12 pounds watermelon would be examples. There are quite a few nuances to this when we introduce casepacks, inner casepacks, and prepacks.  But the concept is still the same as long as the unit we’re measuring can also be measured with a currency valuation.

Unit Additions:

  • BOH – Beginning Onhand Inventory
  • RCPT – Receipts
  • XFER-IN – Transfers In
  • ADJ UNT – Unit Adjustments
  • CUST RTN – Customer Returns

Unit Reductions:

  • SLS – Gross Sales
  • XFER-OUT – Transfer Out
  • VNDR RTN – Vendor Returns
  • SHRINK – Shrinkage Loss or Damage

Cost

Cost (CST). The cost valuation measures the investment you have made in the inventory.  This is by far the most challenging valuation. Every retailer has a slightly different definition of the cost basis depending on the accounting practices they have.

Most retailers employ a perpetual inventory valuation, while a fraction still use periodic valuations.  Perpetual just means the inventory is recalculated regularly, usually daily.  Periodic is usually after a physical count.  What’s important is that the cost basis includes everything that was physically deployed to procure the goods on the first receipt.

This is where things get nuanced.  The purchase order cost plus the freight and duty to get the inventory to the distribution center is a typical way to calculate the cost basis.  Whereas, the freight to the store and the receiving costs in the store may or may not be included, as those are transfer costs which are considered below the gross margin line. All subsequent costs like distribution may be considered outside of the cost basis and reconciled on the profitability report.

For the details of calculating the cost basis, I highly recommend Leo F. Griffin’s book entitled “Retail Auditing, A Practitioner’s Guide”, 1998 published by John Wiley & Sons, Inc.  It’s old, I admit but the principles haven’t changed at all.  My copy still has the original 3.25″ floppy disk.

There are significant nuances to calculating the cost basis.  Retailers will typically employ one of these methods to calculate the cost in the stock ledger.  The general ledger will use standard GAAP and will need to be reconciled to the stock ledger periodically.

  • LIFO – Last In, First Out.  The last receipts are the first to be sold.
  • FIFO – First In, First Out. The first receipts are the first to be sold.
  • Cost Averaging – Very popular method.  Each receipt is added to the last receipt and averaged on a per unit basis, or an AUC.
  • Standard Cost – a standard cost is given to a product and is reconciled at the end of a fiscal period, typically the end of the fiscal year.  Sometimes retailers won’t know the cost at the time the product is set up in the merchandising systems.  This simplifies the perpetual inventory calculations but introduces some issues with subsequent calculations, like gross margin.
  • Retail Inventory Method – before computers this was the preferred method as it estimates the ending inventory on a retail valuation and cost valuation.  The cost of goods sold is then estimated.  A huge assumption is made that the receipts are grouped by margin.  If the margins within the estimation vary widely, the estimate will lead to erroneous results.  Great book on this is “Retail Inventory Method Made Practical” by James T. Powers of Peat, Marwick, Mitchell & Co., 1971, published by the National Retail Merchants Association (NRMA).

Cost Additions:

  • BOH – Beginning Onhand Inventory
  • RCPT – Receipts
  • XFER-IN – Transfers In
  • ADJ UNT – Cost Adjustments Associated with Unit Adjustments
  • ADJ CST – Cost Adjustments
  • FREIGHT – Freight and Duty
  • GAIN – Currency Gain
  • CUST RTN – Customer Returns

Cost Reductions:

  • SLS – Gross Sales
  • XFER-OUT – Transfer Out
  • VNDR RTN – Vendor Returns
  • SHRINK – Provisions for Shrinkage Loss or Damage

Wholesale

Wholesale (WHSL).  This valuation measures what the wholesale customer paid for the merchandise.  This cost can be taken directly off of the sales order.

An important distinction must be made here.  To you, a transaction to a wholesale customer is considered a sale (or shipment).  To the wholesale customer, this transaction is considered a receipt.  When we start calculating the gross margin we’ll need to make the distinction of perspective: whose gross margin?

I’ll discuss perspective more in the nextpost.

Wholesale Additions (your company’s perspective):

  • BOH – Beginning Onhand Inventory
  • RCPT – Receipts
  • XFER-IN – Transfers In
  • ADJ UNT – Wholesale Adjustments Associated with Unit Adjustments
  • ADJ WHSL – Wholesale Adjustments
  • FREIGHT – Freight and Duty
  • GAIN – Currency Gain
  • CUST RTN – Customer Returns

Wholesale Reductions (your company’s perspective)

  • SLS – Gross Sales or Shipments
  • DISC WHSL – Wholesale discounts
  • XFER-OUT – Transfer Out
  • VNDR RTN – Vendor Returns
  • SHRINK – Provisions for Shrinkage Loss or Damage

Retail (RTL).  Retail measures the inventory valuation at full price, or what is on the price tag at the moment; but, with one exception: sales. The sales is measured by what is paid by the customer, or point-of-sale, usually a cash register.  Example: the price of a phone may be $400 but the customer buys it for $320 because there was a 20% off coupon.

For retailers that value their inventory at retail, there is an additional set of markdown metrics that are needed to distinguish between permanent and temporary.

A permanent markdown is one where the inventory valuation is reduced permanently to reflect changes in business conditions.  The inventory is not expected to return to the original valuation.  These types of markdowns are price reductions, clearance, and liquidations.

A temporary markdown is almost always some type of point-of-sale markdown like a promotion. During a promotion the value of the inventory remains at full price until it is sold.  Once sold, the markdown is applied at that time.  There can be many types of temporary markdowns: traditional promotions, temporary price reductions, employee discounts, and loyalty discounts to name a few.

Retailers that employ cost averaging generally don’t have such a complex set of markdown metrics.  Instead they rely more heavily on discounts,  The difference between the estimated full price of the inventory and the actual sales amount.  In this scenario, all markdowns are temporary markdowns taken at the cash register or point-of-sale.

Retail Additions (your company’s perspective):

  • BOH – Beginning Onhand Inventory
  • RCPT – Receipts
  • XFER-IN – Transfers In
  • ADJ UNT – Retail Adjustments Associated with Unit Adjustments
  • ADJ RTL – Retail Adjustments
  • GAIN – Currency Gain
  • CUST RTN – Customer Returns

Retail Reductions (your company’s perspective)

  • SLS – Gross Sales From The Point-Of-Sale
  • MD PERM – Permanent Markdowns
  • MD TEMP – Temporary Markdowns (Discounts)
  • XFER-OUT – Transfer Out
  • VNDR RTN – Vendor Returns
  • SHRINK – Provisions for Shrinkage Loss or Damage

Full Price or MSRP

Full Price (MSRP).  The full price measures are exactly the same as retail except for sales which is measured at full price without the discounts or markdowns.  This set of measures is generally not shown but rather is used in the background to calculate discounts for those retailers that only employ temporary markdowns.

Full Price Additions (your company’s perspective):

  • BOH – Beginning Onhand Inventory
  • RCPT – Receipts
  • XFER-IN – Transfers In
  • ADJ UNT – Retail Adjustments Associated with Unit Adjustments
  • ADJ RTL – Retail Adjustments
  • GAIN – Currency Gain
  • CUST RTN – Customer Returns

Full Price Reductions (your company’s perspective)

  • SLS – Gross Sales
  • XFER-OUT – Transfer Out
  • VNDR RTN – Vendor Returns
  • SHRINK – Provisions for Shrinkage Loss or Damage

Part 1: Inventory Balance Set | Part 2: Units of Measure | Part 3: Perspectives and Types