How inventory works and why it’s important in your handmade business

How inventory works and why it’s important in your handmade, creative, or craft business can be totally confusing to understand.

Running a handmade, creative, or craft business is a labor of love. The overhead required to keep it running smoothly is usually your precious time and energy.

Inventory has a LOT of moving pieces – and your bookkeeping system has to be able to keep track of them ALL! A good bookkeeping system is the foundation to make or break your handmade business.

You probably know that you need to keep track of your inventory but you might not know how. So you put it off and put it off – until it becomes this HUGE major chore.

What you may not know, or understand, is that you need to keep track of your inventory – from the time you buy a skein of yarn – right up until you sell a finished item that was made from that skein of yarn.

When you finish reading this post, you’ll know how inventory works and why it’s important in your handmade business,. Here’s what I’ll be including:

• What is inventory
• The bookkeeping flow for keeping track of the value of your inventory
• Information you need to know (and report) about inventory on your tax return
• What information a good bookkeeping system includes about inventory
• Which should you choose to track inventory in your handmade business – Spreadsheets or Software?
• Tips for starting an inventory system

Grab your favorite beverage and let’s do this!

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What is inventory?

Inventory is an Asset – meaning it is something that your business owns that has value and can be sold to raise money. Assets and Inventory are part of your Balance Sheet.

Inventory can consist of:

• materials & supplies that you buy and keep on hand (anybody wanna say yarn stash?)
• items that you’re working on (WIPS)
• finished items that you have in stock to sell, or
• the finished items that are in someone’s shop or a crafter’s co-op (on consignment)

All of these have a dollar value that you need to keep track of for various reasons.

You may even have different types of inventory, depending on what you do.

For example, if you’re a:

• maker, your inventory will consist of materials & supplies, WIPS, and finished items
• designer, your inventory might include materials you’ll use for future projects and finished samples that you sell, gift, or keep for yourself
• tech editor, you might keep a small inventory of inexpensive yarn on hand to be used if you need to reproduce a part of a pattern you are editing.

The bookkeeping flow for keeping track of the value of your inventory and why it’s important

Stumped about how to keep inventory for your handmade business?

Well, there’s a definite bookkeeping flow for keeping track of your inventory – and it’s worth repeating that inventory has a LOT of moving parts!

As a business owner, it’s your responsibility to keep track of the value of your inventory as it moves through each stage of it’s life, in your bookkeeping system.

Here’s the bookkeeping flow of inventory.

When you:

• buy yarn, the cost goes into Materials Inventory
• take yarn out for a project, the value of the yarn you’re removing needs to be tracked as you work on your WIP
• finish the WIP, the value of ALL the materials you used in the finished items goes into Finished Items Inventory
• decide to put that item on Consignment, the total value of that item gets moved from Finished Items Inventory into Consignment Inventory
• finally sell that item, the total cost (value) to make the item is removed from Finished Items Inventory (or Consignment Inventory) and is moved so it hits the Cost of Goods Sold – Materials account on your Profit & Loss Report. And, what you sold it for hits Income

WOW! That’s a lot of tracking!

I know inventory is tough, confusing, and time consuming. This is also where I see a lot of bad bookkeeping advice, that can get you into trouble.

The information you need to know (and report) about inventory on your tax return and why it’s important

You need to keep detailed records to satisfy the IRS.

The IRS wants some very specific things reported on your Schedule C in the Cost of Goods Sold section of your tax return. Here’s what they want to know about your inventory:

• method you use to figure out the value of your inventory
• value of your inventory at the beginning of the year (January 1)
• the value of your inventory that you purchased this year MINUS anything you took out for personal use
• inventory value at the end of the year (12/31)

These things are very specific and it means you have to keep track of a whole lotta stuff to come up with the numbers.

Oh, and tracking your stash in Ravelry is NOT enough! Sure, Ravelry makes it pretty and it’s visual – but you need a detailed accounting of costs to satisfy the IRS. You just aren’t going to get that from Ravelry because there’s no way to pull reports.

What information a good bookkeeping system includes about inventory

Let’s talk about what a good inventory system should include. 

I’m probably going to make you groan……AGAIN! A good inventory system includes A LOT of detail about all those moving parts!

Let’s talk about what information you need for yarn inventory. 

First, we need some general info about what’s going into inventory.

• Date of purchase
• Brand & type
• Colorway
• # of skeins purchased

Depending on how you determine your cost or what’s left in inventory after you’ve used it in a finished item, you’ll need to know:

• Yard or meters per skein/Ounces or grams per skein
• And Total Yards or meters purchased/total ounces of grams purchased
• Number of yards per ounce or gram

And, then you need to know the:

• Price you paid per skein
• Cost per yard or gram -which you’ll use for COGS calculations
• The total you paid

All of this covers what increases your inventory

Next, you need to know what you’ve used in your finished items to calculate the Cost of Goods Sold for each item and what you’ve removed from inventory for personal use, to give to charity, or maybe even sell:

• Yards/meters used in finished items, or
• Ounces/grams used in finished items
• Yards removed for personal use
• Yards removed give to charity or to sell
• Total yards removed from inventory
• The cost of the yards removed from inventory
• Total yards used/removed (so you can calculate yards left)
• The number of yards left in inventory

Increases and decreases provide you with the running balance or value of your materials inventory.

Next, you need to know information about what you’re selling it for:

This goes just a tad into pricing. 

Here’s a super quick example.

Let’s say you bought a skein of yarn that NORMALLY retails for $3.17 a skein, you got it on sale and paid $2.53 for it. 

Now you’ve got two different prices going on here.

Let’s say you use the entire skein to make an item or a design sample.

When you do your Cost of Goods Sold Calculation, you’re going to use the $2.53

BUT, when you calculate your Sales Price of the item, you’re going to use the $3.17. 

Because, you can’t guarantee that you’ll be able to get that same yarn on sale again if you use the same yarn to make a 2^nd item on down the road.

A good inventory system also includes information about:

• Retail price per skein
• Retail price per yard or ounce

You may be thinking “man she was right – that’s a lot of moving pieces and things to keep track of”. 

Which leads us to………..

Which should you choose to track inventory in your handmade business – Spreadsheets or Software?

How you track your inventory is totally up to you – I’m NOT going to tell you what you have to use. 

Instead, I want to provide you with some information to help you make an informed decision.

FYI, tracking your inventory in Ravelry is NOT enough.

I just thought I’d throw that out there because I know that many people track their stash and finished items in Ravelry.  I’ve even heard some of the handmade business coaches recommend this, but I do want to warn you, that is NOT considered enough for tax purposes. 

You need that detailed accounting of costs to satisfy the IRS and you just aren’t going to get that from Ravelry.

So, Ravelry is out. 

That leaves us with spreadsheets or software. 

With spreadsheets you could need between 4 and 17 different spreadsheets, with multiple columns of information that you need to keep updated all year long.

If you think you want to use spreadsheets to track your inventory – Here’s a link to a blog post about tracking inventory using spreadsheets and it’s included in the “The 10-Minute Bookkeeper – Handmade Business Spreadsheet Bookkeeping System“.

Software can help, but even it’s not perfect. Some software programs handle inventory, others don’t – it all depends on what you choose and if you want to spend money or not.

Instead of writing it all out and making this post longer than it already is, I thought I’d provide you with a video that’s included in a membership to the Handmade Business Bookkeeping Academy.

How inventory works and why it’s important in your handmade business – tips for starting an inventory system

Starting at the beginning of the year (if possible), create a system to keep inventory for both finished items and materials.

When you first start REALLY tracking your inventory, you’ll have to do some counting to determine what you have on hand, but you have to do that anyway for yearly inventory. 

Just enter the starting item quantity with the date you begin to keep inventory (and use that same starting date for the other finished items). 

Keep your inventory system updated!

Don’t slack on maintaining your inventory system throughout the year.  It’s designed to help you know exactly how many of any particular item you have in stock at any given time.  Also, record what your using and what you’re buying, so that you know when to re-order supplies.

At the very end of every year, you’ll need to figure out inventory and costs for both materials and finished items for your tax return. 

Using the numbers from your inventory system is much easier than counting everything by hand – year after year after year! 

Now that you know how inventory works and why it’s important in your handmade business, taking the time to setup an inventory system can make the beginning of every year a whole lot less stressful! 

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Looking for more posts about inventory and cost of goods sold? Check these out:

• What is inventory?
• How to track inventory
• Tracking your finished items inventory using spreadsheets
• Year-end physical inventory tips
• Why track Cost of Goods Sold
• When does inventory and cost of goods sold hit my bookkeeping?

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Did you skim or skip to the end of this post?

That’s ok, here’s an overview of what I talked about:

• What inventory is
• The bookkeeping flow for keeping track of the value of your inventory
• What you need to know about inventory for your tax return
• What information a good bookkeeping system includes
• Spreadsheets or Software – which should you choose to track inventory for your handmade business
• Tips for starting an inventory system

What do you think?

Is setting up an inventory system for you handmade business and keeping it updated worth it? Leave your thoughts in the comments below.