Keeping track of trading stock is a vital part of running any small business day to day, but it becomes particularly important during tax time. Most people aren’t aware that damaged or outdated stock at the back of your storeroom might actually be worth something. And that by doing a stocktake, you can deduct the fall in value of your trading stock against your business income at tax time. Here’s a few tips on how to do this easily and efficiently.
The basics to get started
Doing a stocktake during tax time involves comparing the value of your stock at the end of the financial year against its value at the beginning of that year. This often takes some time, as it requires a physical check of what is on your shelves against what is in your business accounts.
But there are major benefits: along with increasing your tax deductions, doing a stocktake will also give you a clear idea of your old inventory so you can consider getting rid of it, turning it into quick cash, or throwing it away (after the tax deduction).
Make sure you do the stocktake outside of business hours, when there aren’t any transactions or stock changes taking place.
It’s also best to ensure your stocktake records contain a list of each item of stock on hand, its value, the person who counted the stock, how and when, who valued the stock and the basis of the valuation. Save these records in case the ATO asks to see them as part of your tax return.
A stocktake to determine the value of your goods has one of two major effects on your tax return:
- If the value of the trading stock is higher at the end of the year than at the start, then the increase counts as part of your taxable income.
- If your stock is worth less, you qualify for a deduction.
Be mindful that stock isn’t just limited to items you sell to customers. It can also be ingredients or materials used to manufacture or distribute your goods, such as packaging. Also remember that not everyone has to do a stocktake during tax time. Small businesses who estimate their stock values have changed by less than $5000 during the financial year are exempt from doing a stocktake.
The three methods
There are three different methods of valuing trading stock. You can opt for the one that provides the lowest valuation at the end of the year, allowing you to maximise your tax deduction. You can even use different valuation methods for different items. These are:
1. Cost: This refers to how much the goods cost you. This isn’t just the purchase price, but other costs associated with the stock, such as shipping and delivery charges, insurance, customs and excise duties.
2. Resale value: This is the current value of stock if it were sold. For example, imagine that you sell books and after doing a stocktake, you discovered that you had 100 travel guides from 2012 left over in your warehouse. While they cost you $10 each back in 2012, you can now only sell them for $2 each because they have become outdated. In this case, you’d get an $800 tax deduction for the decrease in value (the $1,000 cost of the books minus the $200 value that you could sell them for today).
3. Replacement value: The third method of valuing stock is its replacement value, that is, what it would cost to obtain a substantially identical item.
All small business owners should constantly be looking at what is selling, what isn’t, and how they can shift the slow-selling items to boost cash flow.
Systems like these help you track which of your goods have been sold and the price they were sold at, ensuring that the process of doing your stocktake is accurate and efficient.
James Solomons is Head of Accounting at cloud accounting provider Xero Australia.