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A guide to the retail inventory method (RIM)

Performing a physical inventory is a time-consuming process, as any retail business owner knows. It takes time and manpower, while sometimes requiring the store to be shut down while the inventory is performed. The retail inventory method (RIM) offers a way to obtain an educated guess of how much stock remains in any given accounting period. Here’s a look at how this works and when the RIM might be useful.

Retail inventory method definition

There are numerous accounting tools you can use to reconcile payments, including accounting software programs. For quick calculations, the retail inventory method is used by retailers to estimate any ending inventory balance. The calculations are based on the balance between product cost and retail price. It’s important to note that the retail inventory method isn’t 100% accurate. As a result, it should be followed up by the physical inventory count for your firm’s year-end financial statements.

Retail inventory method formula

When a retailer is left with remaining inventory at the end of any period, the retail inventory method offers a simple process to calculate its cost:

  1. Step 1: Use the retail inventory method formula of Cost / Retail Price to calculate the cost-to-retail percentage.

  2. Step 2: Determine the cost of goods available by adding the value of your business’s beginning inventory to the cost of purchases.

  3. Step 3: Tally up the cost of sales during the period in question, multiplying the sales by your cost-to-retail percentage.

  4. Step 4: Calculate the final ending inventory amount, subtracting the cost of sales during the period from your cost of goods available for sale. 

Retail inventory method example

Here’s a hypothetical example of how this would work in practice. If a hot sauce vendor sells each bottle for $5 after purchasing each one for $3 at cost, the cost-to-retail percentage would be 60%. The company’s beginning at-cost inventory was $10,000, and it paid $10,500 for additional purchases throughout the month. Its overall sales figures were then $30,000. To calculate its ending inventory using this retail inventory method example, here’s what you need to do:

Beginning inventory

$10,000 (at cost)

Monthly purchases

+ $10,500 (at cost)

Goods available for sale

=$20,500

Monthly sales

-$18,000 (sales of $30,000 x 60%)

Ending inventory

$2,500 (remaining inventory at cost)

This would provide a reasonable level of accuracy because the bottles of hot sauce didn’t experience any changes in at-cost or mark-up value during this monthly period.

Retail inventory method advantages

For time-crunched retailers, the retail inventory method is a quick and helpful way to get a handle on their merchandise value. There are several circumstances in which it’s a valid accounting method for inventory management, provided that you remember it can only provide estimates.

Wholesalers will find the retail inventory method useful, particularly if they deal with large volumes of products with a consistent mark-up value. Similarly, warehouses storing the types of products that change very little in value from one season to the next can accurately use the RIM, as can those with a slow turnover ratio.

Businesses with multiple retail locations will often use the retail inventory method since it’s difficult to coordinate a physical inventory across multiple simultaneous spaces. This method is also useful for businesses with goods in transit. As no-inventory storefronts gain popularity, the retail inventory method is needed to keep track of stock on the move.

Even for faster-moving retail businesses, the retail inventory method can work provided that the firm has access to accurate demand forecasting. If prices can be negotiated in the long term, this would create a precise mark-up value forecast.

Retail inventory method limitations

Although it provides a quick, simple way to determine a retail inventory balance, there are limits to using the RIM that you should consider before moving forward. Firstly, it only provides an estimate. If you’re calculating year-end financial forms, this won’t be sufficient. A physical inventory count is time-consuming and costly, but it’s the most accurate way to get a realistic tally of stock.

Another limit to the retail inventory method is that it only works for products with a consistent mark-up. Some types of merchandise vary widely in price over a financial year. In which case, the RIM would be too inaccurate. A mark-up percentage must continue into the current term. Short-term differences in price caused by something like a Black Friday sale would throw the calculation off.

Finally, if there’s been an acquisition and the inventory’s mark-up percentage has been changed by the acquirer, this method wouldn’t be accurate.

Is the retail inventory method right for my business?

Although it doesn’t provide the accuracy that a methodical physical inventory count can, the retail inventory method can be useful. It’s best applied in warehouses where product mark-up stays constant for more extended periods. This lengthens the amount of time between physical inventory counts.

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