This is the story of Backstop Bob. Backstop Bob owns and operates Backstop Bob’s Baseball Emporium. Backstop Bob sells baseball bats. He thinks that he has been very successful.

Every month, Bob reviews his financial statements with his accountant. Each month, he is told that he is making money. At the end of the year, he completes his inventory count and suddenly, the profit turns into a loss. Poor Bob!

Backstop Bob’s experience is pretty typical of any organization that has a large inventory. The problem centers around how much each item that is sold costs at the time of sale. In Bob’s case, when he sells a bat for $40, he figures that 50% of that amount is the cost to him of the bat. Typically, client’s like Bob will come up with a percentage based on how they mark their products up. In Bob’s case, he always doubles his cost to come up with a price, so he knows that his cost is 50% of his sale price. With other retail owners, there can be a multitude of mark ups that they deal with in their inventory. For example, one type of baseball bat might allow Bob to only double the cost amount to come to a sale price, others might allow him to triple or quadruple his cost amount to come to a sale price. This makes the cost percentage calculation tricky.

So in Bob’s case, he has determined that the cost of each bat is 50% of the selling price. Each month, as he sells his bats, his accountant takes the total sales, divides that number in half and records that as the cost of goods sold (COGS). The accountant will then adjust the inventory either higher or lower to reflect the difference between the suppliers invoices paid and the cost of the bats that have been sold. This works well for some companies. Unfortunately for Bob, this isn’t the case.

There are many reasons why Bob’s cost might be higher than the 50% that he thinks it is. One factor is Crooked Kyle. Crooked Kyle works for Bob. Crooked Kyle loves to take bats home to give as gifts to his friends and family. Crooked Kyle also loves to give discounts to everyone. So if a bat sells for $40, Kyle helps Bob out by selling it for $35. Unfortunately for Bob, he doesn’t know any of this.

So at the end of the year, Bob’s accountant asks him to count the inventory. He comes in on Sunday, spends the day counting bats, works late into the night to come up with the total cost of the inventory and e-mails that to his accountant. Two days later, Bob gets a call from his accountant. The profit of $40,000 that they were looking at in their last meeting has now changed into a loss of $40,000. Bob just shakes his head. He thought that he was doing so well this year.

So what can be done to correct the situation? Many companies have solved this situation by using a point of sale (POS) system that keeps track of the items going into inventory and coming out of inventory. Other client’s will do inventory counts more often. Many clients will also install security systems that monitor the inventory so that the Crooked Kyles of the world find it difficult to steal the products. Other client’s will change their business models to reduce the inventory to a bare minimum and only acquire the stock when needed. All of these approaches can go a long way to strengthen the accuracy of the financial statements of any retail organization.