A Step-by-step Guide to Writing Off Inventory
While inventory write-offs are nobody’s favorite activity, they are essential to save yourself from landing in a major budget confusion crisis. Not writing off inventory timely can lead to lots of mismatching between your balance sheet and your income statement, and cause the need for lengthy recalls to explain everything. Therefore, whenever any loss, misplacement, or damage to inventory occurs, it must immediately and systematically be written off.
This way you can ensure accuracy in your financial statements. Suppose you want your own team to focus on other operations. In that case, you may collaborate with a third-party logistics company such as ShipBots to streamline your inventory management and other eCommerce fulfillment operations. This blog post will highlight the reason and importance of writing off inventory, share a step-by-step procedure for writing it off and explain how you can benefit from collaborating with 3PLs for this.
What is Inventory Write-off?
Inventory write-off is the procedure of reducing or completely removing those items from inventory accounting records that have lost value for businesses. Inventory is written off due to multiple reasons including loss, theft, or damage to the inventory as well as when market value begins diminishing.
When Should You Write Off Inventory?
As a business grows, inventory write-offs become inevitable especially if left untreated with their causes unidentified. Inventory write-offs are minimizable by opting for the right course of action. The most common reasons behind these write-offs are:
When Inventory is Perishable
If your business deals with perishable items such as food, drinks, or anything with a brief shelf life, many items will need to be written off if they reach expiration before being sold. It’s best to not overstock in such cases.
When Inventory Gets Damaged within the Supply Chain
If due for any reason, the supply chain faces unplanned operational breaks or malfunctions, it can lead to the production of damaged or defective products, that will need to be written off. If sold to a customer in such a state, the customer will need to be reimbursed.
When Inventory is Stolen
At times, businesses face the unfortunate event of theft of products either by the general public entering their premises or by their own employees. When your inventory assets don’t match the physical counts, there has either been a lapse in records or some criminal activity. Either way, it needs to be written off.
When Inventory Becomes Obsolete
Some products are hotshots in one season and totally out of demand in the next, for instance, fast fashion clothing items. When market value becomes obsolete, it’s best to quickly write off such products and discontinue any further purchases.
What are the Steps to Writing Off Inventory?
Accounting for inventory write-offs does not need to be a complex process. You just need to accurately evaluate the loss and/or damage to your inventory reserves and report them in the correct account. Once done, you need to locate and fix the cause of that damage to prevent further loss of inventory.
Step #1: Evaluate the Amount of Damaged Inventory
Start off with determining the exact amount of inventory that has been exposed to any kind of damage. Next, write it off from the gross inventory. Even If you receive a new shipment containing some inventory that has been damaged, begin with sorting undamaged and sellable items from the damaged lot.
Step #2: Calculate the Total Loss
Once you have determined the number of inventory items that have been subjected to damage, shift towards calculating the financial loss. You can do this simply by multiplying the cost-per-unit of items with the number of damaged items.
Step #3: Add the Loss to the Inventory Expense Account
Most businesses set up an account for writing off inventory to record the value of inventory that has been written off from their current assets. Once you have calculated the financial impact of a certain loss in inventory, you must add it up to the inventory expense account, and change (reduce) the amount of available inventory. For some exceptions, inventory write-offs are accounted as tax-deductible.
Step #4: Debit COGS and Credit Inventory Write-off
The next step is to debit your Cost of Goods Sold (COGS) and credit your inventory write-off expense account, on your balance sheet.
Step #5: Evaluate the Cause of Damage
Lastly, you need to take action to prevent this from recurring in the future. The only way to do this is to get to the bottom of the cause behind this write-off. Figure out how the inventory got lost or how the damage was incurred, trace back everything throughout the supply chain and make necessary changes to prevent reoccurrences.
How are ecommerce Businesses Affected by Inventory Write-offs?
Due to a lack of proper, data-driven customer demand forecasting, some businesses stock up unnecessarily high amounts of inventory. It is an unproductive expense and leads to write-offs and financial loss.
How can an Expert 3PL Reduce your Inventory Write-offs?
Traditional supply chains in some businesses do not operate with thorough communication meaning operations such as purchase, and manufacturing is indifferent to customers’ actual demand. This is the primary cause of inventory write-offs, and an expert 3PL such as ShipBots can help you prevent that. 3PLs make use of data insights and calculate the actual demand that reflects seasonal variations.
Moreover, third-party logistics such as ShipBots can optimize and streamline your supply chain processes, bridge the communication gap between upstream and downstream activities, improve your inventory management, enhance your KPIs and control the amount of capital tied up in unproductive inventory. This way, your inventory write-offs will soon be minimized.