Andrew is a small limited company business owner who is struggling to make sense of accounting for stock. He has heard that stock can be calculated from his GP (Gross Profit) Margin but he doesn’t know how to to do that and has asked for our help.
How to Calculate Closing Stocks from a GP Margin
So we need to understand some basic accounting principles:
- Cost of sales is >> Opening Stock + Purchases – Closing Stock
- Gross Profit is >> Sales – cost of sales
Andrew builds wooden dolls houses. Each one is custom built and shipped directly to the customer on completion. So let’s assume that Andrew knows his numbers and he knows that a house will cost him £30 in direct labour and materials to build and £5 to ship to his customer. These are his direct costs. He sells each house for £100.
We now know that:
- Unit Sales = £100
- Unit Cost of Sales = £35 or 35% or 0.35 expressed as a decimal
- Unit Gross Profit is £65 or 65% or 0.65 expressed as a decimal
Opening stock would be brought forward from the previous month, say this is £275, enough to build approximately 7 houses.
Purchases = the value of your stock purchases that month, say this is £50 – you only needed a few extra bits.
Sales for the purpose of this example, is 500 or 5 houses in that month.
|What we know||Final figures|
|Less Closing Stock||(???)||The movement to closing stock must be calculated:
175 – 275 – 50 =
|= Cost of Sales (35% of sales)||175||Calculated = 500*0.35||175|
Simple Stock Calculations
Instead of putting purchases through your Profit and Loss Account, a simpler approach would be to post all stock purchases to a stock account in your balance sheet.
At the end of each month, your accounting adjustment would be a single journal to post your cost of sales value from Stock in the Balance Sheet to Cost of Sales in the Profit and Loss.
31-Dec- xx Being the cost of sales adjustment for Dec-xx
|Cost of Sales (500 x 0.35)||175|
Avoid nasty surprises
Your valuation of closing stock should be based on more sound principles that the GP margin. Sales prices change, costs of goods change so your GP Margin assumptions could be wrong.
Stock held in the balance sheet at the lower of cost or net realisable value. Run a stock check at the end of the year (quarterly is better), look for old lines, dead stock, broken stock and write this off so that the carrying value of stock in your balance sheet is a fair value of the actual stock you hold.
Run a stock check at the end of the year (quarterly is better, monthly better still if possible), look for old lines, dead stock, broken stock, missing or stolen stock and write this off so that the carrying value of stock in your balance sheet is a fair value of the actual stock you hold.