How small businesses can keep cleaner cost of goods sold records

Cost of goods sold becomes much easier to discuss at tax time when the records behind it have been organized all year. For product-based businesses in Dane County, that may mean keeping vendor invoices, purchase receipts, freight records, and inventory counts together instead of rebuilding twelve months of activity in January. At the Latino Chamber of Commerce of Dane County, we encourage members to make recordkeeping part of the monthly routine rather than a once-a-year tax project.

Start with the records you already create

Most businesses already generate much of the documentation a tax preparer will need. Vendor orders, invoices, receipts, shipping charges, inventory reports, and purchase confirmations all help show what came into the business and what remained on hand.

The IRS allows businesses to choose a recordkeeping system that fits the business as long as it clearly shows income and expenses. Paper files can work. So can bookkeeping software or a spreadsheet. Consistency matters more than choosing a complicated system.

A simple monthly folder can hold:

• vendor invoices and purchase receipts;
• freight-in or shipping records tied to inventory;
• credits, returns, and supplier adjustments;
• notes about damaged, donated, or missing merchandise;
• a current inventory list with quantities.

That gives your bookkeeper or tax preparer a trail to follow. It also makes it easier to answer questions while the transaction is still recent.

Know what belongs in cost of goods sold

Current IRS guidance explains that businesses that make, buy, or sell goods to produce income may need to determine inventory at the beginning and end of the year when figuring cost of goods sold. Purchases for resale, materials, and certain production-related costs can also matter depending on the business.

The rules are not identical for every company. A retailer, food producer, craft business, and manufacturer may each have different records behind the final calculation.

Keep the source documents rather than trying to make every tax decision yourself. Your tax professional can decide which costs belong in the calculation based on your business and current tax rules.

Do not mix owner use with business inventory

Sometimes an owner takes merchandise home, gives a product to a family member, or removes an item from stock for personal use. Mark that transaction when it happens.

The IRS distinguishes merchandise withdrawn for personal or family use from inventory purchased for sale. A short note in the inventory record can prevent confusion months later.

Use the same habit for damaged or donated products. Record what happened, when it happened, and which items were involved. Your preparer can then determine the proper tax treatment.

Service businesses may handle this differently

A business that mainly sells services may not calculate cost of goods sold when merchandise is not an income-producing factor. Current IRS guidance makes that distinction clear.

Some service businesses also sell materials or products. A contractor may provide a service while charging for materials, for example. That is where a tax professional should review the facts instead of applying a general rule from another business.

Make the year-end inventory count easier

A year-end count is much less stressful when the product list stays current. Do not wait until the final week of the year to discover that item names, supplier information, or quantities have not been updated for months.

During the year, track the information that will make the final count easier:

• product or material name;
• supplier;
• quantity on hand;
• units removed from sale;
• date of the ending inventory count.

Two short inventory reviews during the year can also uncover recordkeeping gaps before tax season.

Where our members can go next

Business support organizations, Spanish-language tools, and local technical-assistance options can help owners build stronger systems before they meet with a tax professional. We encourage members to use those resources as a starting point and bring organized records to the conversation.

The IRS also publishes current small-business recordkeeping guidance and Publication 334 for federal tax information. This article is general education, not individual tax advice. A qualified tax professional can apply the current rules to your business, accounting method, and inventory situation.