Here's how the gross profit method works. First you must determine the gross profit percentage (gross profit margin) that your company is currently experiencing. For example, if a retailer buys its merchandise for $0.70 and sells the merchandise for $1.00, it has a gross profit of $0.30. The gross profit of $0.30 divided by the selling price of $1.00 means a gross profit margin of 30% of sales. This also means that the retailer's cost of goods sold is 70% of sales.
Next, compute the sales value of the merchandise sold since the last time an inventory amount was known. Let's assume that the sales amounted to $100,000. Given the sales value of $100,000 the cost of the goods sold should be approximately $70,000 (70% from above times $100,000).
Add the cost of the goods purchased since the last inventory to that inventory amount. Let's assume that previous inventory amount was $15,000 and that there were purchases of $75,000. That means the cost of goods that were available for sale totals $90,000 ($15,000 + $75,000). Since the estimated cost of goods sold was $70,000 (from above), the estimated cost of goods in inventory should be approximately $20,000 ($90,000 minus $70,000).
Be certain that the gross profit percentage is indicative of reality and remember that the resulting amount is an estimate.
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