Retail accounting: Understanding the retail inventory method

Published 10 March 2026

Table of contents

• What is retail accounting for inventory?
• How the retail inventory method works
• How to calculate ending inventory with the retail inventory method
• Retail accounting vs inventory cost accounting
• Streamline your retail accounting with Xero
• FAQs on retail accounting and inventory

Key takeaways

• The retail method of inventory valuation lets you estimate ending inventory and cost of goods sold quickly, using the cost-to-retail ratio.
• To use the retail inventory method, you must know the beginning retail value of your inventory, the retail value of purchases, and sales over a specific time period.
• Retail accounting works best with similar items and consistent pricing, while inventory cost accounting is better for unique or volatile items.

What is retail accounting for inventory?

Retail accounting for inventory refers to the retail inventory method (RIM). The RIM gives you estimates of two things:

• your ending inventory value (based on cost), and
• cost of goods sold (COGS) over the time frame being measured.

It’s a fast way to understand your inventory without you having to count it manually. The retail method supports a periodic inventory system – which is when you check inventory levels and costs annually, quarterly, monthly, or even more frequently. However, many retailers prefer using a perpetual inventory system – which is when you use software to track inventory levels and costs constantly (perpetually) in real time.

How the retail inventory method works

The retail inventory method estimates the ending value of your inventory based on the relationship between your inventory’s cost and its retail price.

• To estimate the ending value of your retail store inventory, multiply the retail value of your inventory at the end of a period by your cost-to-retail ratio (the relationship between what you pay for inventory and what you sell it for).
• To estimate your cost of goods sold, multiply sales for the period by your cost-to-retail ratio.

You’ll find these calculations of the retail method of inventory valuation below.

The IRS’s Publication 538 has a section on the retail method of inventory accounting (as well as information on business accounting and tax preparation).

How to calculate ending inventory with the retail inventory method

Here’s how to calculate inventory value using the conventional retail inventory method. The retail inventory method works best when inventory items have a relatively consistent markup. Calculations can be more complex if you include factors like additional markups, markup cancellations, and shrinkage.

1. Calculate your cost-to-retail ratio

The cost-to-retail ratio is simply the wholesale cost of your items divided by their retail price:

Wholesale cost / retail price = Cost-to-retail ratio

If you buy 20 coats for $400 and sell them for $1000, your cost-to-retail ratio is:

$400/$1000 = 0.4

To convert the ratio to a percentage, multiply by 100. In this case, that gives you 40% – this is your cost-to-ratio percentage or complement percentage.

2. Gather your numbers

To calculate the cost of your ending inventory, you need three numbers:

• wholesale cost and retail price of your inventory at the beginning of the period
• cost and retail value of inventory purchased during the period
• sales revenue for the period

You should have these numbers in your inventory management system, retail accounting software, or whatever you use to track your inventory.

Here’s an example to explain how the retail inventory method works:

3. Estimate ending inventory at retail

Here's how you calculate the retail value of your ending inventory:

Beginning inventory at retail + Purchased inventory at retail – Sales = Ending retail inventory

In this example, we started with $100,000 in inventory at retail value, purchased $200,000 at retail, and made $250,000 in sales. Here's how those numbers plug into the equation:

$100,000 + $200,000 – $250,000 = $50,000

That means the ending value of your inventory based on its retail price is $50,000. But how much did that cost you?

4. Convert ending inventory to cost

If you know the retail value of your ending inventory, you can estimate its cost value using the cost-to-retail ratio.

Ending inventory at retail x Cost-to-retail ratio = Ending inventory at cost

Let's continue with the above example. You have $50,000 in ending inventory at retail, and your cost-to-retail ratio is 4/10. So:

$50,000 x 4/10 = $20,000

That means the inventory you have right now is worth $50,000 if sold at retail, but it's worth about $20,000 based on your costs.

5. Calculate your cost of goods sold

Once you have all these numbers, you can calculate your COGS in a couple of ways.

Method 1:

Starting inventory at cost + Inventory purchased at cost – Ending inventory at cost = COGS

With our numbers, that comes to:

$40,000 + $80,000 – $20,000 = $100,000

That means you spent about $100,000 to buy the items you sold. When you file your business tax return, the form will prompt you to calculate COGS using these numbers.

Method 2:

This second method is useful if you already know your sales and your cost-to-retail ratio, and you want to quickly estimate your COGS.

Sales x cost-to-retail ratio = COGS

In this case, you had $250,000 in sales and a ratio of 0.4.

$250,000 x 0.4 = $100,000

Retail accounting vs inventory cost accounting

The retail method is best when you don't have the time or resources to do a manual inventory count. The inventory cost method works best when you can count inventory or track costs and want a precise number.

The retail accounting method lets you estimate COGS or the wholesale value of ending inventory, based on previous inventory levels and sales. In contrast, the inventory cost method uses the exact costs you paid when buying inventory as well as the cost of the inventory on hand.

Note that inventory cost accounting is not the same as cost accounting, which refers to an internal process used to track the costs of goods, services, projects, etc.

Streamline your retail accounting with Xero

If you're trying to figure out how to manage retail inventory, Xero makes managing your retail inventory much easier. Xero syncs with a range of inventory management apps available in the Xero App Store. The moment your inventory details change, Xero automatically imports details about costs, inventory levels, and sales from your inventory records into your Xero organization to update your financial records. That means less manual work and always up-to-date numbers.

Get one month free

FAQs on retail accounting and inventory

Here are some of the most common questions small business owners have about the retail inventory method.

Is the retail inventory method GAAP-compliant?

Yes, the retail inventory method complies with Generally Accepted Accounting Principles (GAAP). GAAP-compliant accounting records make it easier to secure loans and attract investors – and are essential if you plan to publicly list your business.

What is the cost-to-retail ratio?

The cost-to-retail ratio is the relationship between the retail price of your inventory and its cost. It helps you see which portion of your inventory's selling price covers cost, and it can also help you estimate the value of your inventory at the end of any time period where you don't have time to do a manual inventory count. In other words, the cost-to-retail ratio shows how much of each dollar of sales is used to cover inventory costs versus how much is markup.

The simplest way to calculate this ratio is by dividing your cost by your retail price. For example, if your cost is $60 and the retail price is $100, your cost-to-retail ratio is 60 / 100 = 0.6 (60%).

Does the retail inventory method work for omnichannel retailers?

It depends. If you sell products over multiple channels (aka you're an omnichannel retailer) – website, social media, store, etc, the retail inventory method can work if you use consistent markups on your products or use an inventory management system that groups items by their average markup. But the retail inventory method isn't the best option for omnichannel retailers as it uses estimates. To stay on top of inventory levels in multiple locations, omnichannel retailers are better off using systems that provide real-time inventory tracking based on location, combined with regular manual counts.

What is the 80/20 rule for inventory in retail?

The 80/20 rule means that 80% of your profits come from 20% of your inventory, and the remaining 20% of your profits come from 80% of your inventory. In other words, most of your sales come from a relatively small handful of products, but you stock a variety of items to meet customer needs and to pique their interest. To optimize inventory management (and to maximize your profits), make sure you know which 20% of your inventory is driving profits and make decisions accordingly.

Which is better: perpetual or periodic inventory?

Both methods have pros and cons.

• The perpetual method tracks inventory in real time, but you need an inventory management system so you can enter inventory when you purchase it and a point-of-sale system to update inventory records with your sales.
• With the periodic method, you calculate inventory periodically by doing a physical count or using the retail method to estimate inventory value. The periodic method lacks real-time insights but can be easier to use.

How do markdowns affect the retail method?

Markdowns reduce the retail value of your inventory on hand. If you have $100,000 in inventory at retail and you mark down prices a total of $8000, you now have $92,000 in inventory at retail. Markdowns can also change your cost-to-retail ratio, as you're selling products at a lower price. If the cost of your items was $46,000, your cost-to-retail ratio is 46% (based on an inventory retail value of $100,000) – but it's 50% when applied to a retail value of $92,000.