At Finaloop, we're all about flexibility. We offer 2 methods to track your COGS. Select the one that works best for your brand:

Purchase-based method
Sales-based method

We'll walk you through the pros and cons of each so you can decide which is best for you.

Step 1: Understand how each method works

1. Purchase-based Method (‘Record-As-You-Buy’)

Under this method, inventory-related purchases are categorized directly into the relevant account under Cost of Goods Sold (COGS) in your P&L (i.e., COGS, Packaging, Supplies, or Shipping-in). You’ll be able to view all of your inventory-related purchases (from your transactions and bills) under the Purchases screen.

Inventory-related purchases should include:

Finished products,
Supplies and raw materials,
Packaging and labeling supplies,
Shipping/ freight costs to ship the stock TO your warehouse (such as global shipping),
Other indirect vendor costs, such as sales tax and vendor fees, and
Manufacturing/assembly or production costs (e.g., direct labor, contract manufacturers, manufacturing overhead) if you manufacture your own products.

Your COGS in your P&L are based on your purchases of inventory-related items and your inventory balance on your balance sheet is only updated at year-end for tax purposes.

At year-end, we will ask you for your inventory balance at the end of the year, and make the required adjustments to your books to ensure your books are tax ready.

2. Sales-based Method (‘Record-As-you-Sell’)

Sales-based method is the more common method for ecommerce brands to track the current value of their COGS and inventory. Under this method, inventory purchases are categorized as inventory on your balance sheet.

You can view all of your inventory-related purchases (from both your transactions and bills) on your Purchases screen. Inventory-related purchases should include:

Finished products,
Supplies and raw materials,
Packaging and labeling supplies (since these items are usually purchased in bulk but used at the rate of actual sales),
Shipping/ freight costs to ship the stock TO your warehouse (such as global shipping),
Other indirect vendor costs, such as sales tax and vendor fees, and
Manufacturing/assembly or production costs (e.g., direct labor, contract manufacturers, manufacturing overhead) if you manufacture your own products.

All these transactions increase your inventory balance. If anything is missing on your Purchases screen, just go to Transactions to recategorize or add any missing inventory Bills.

COGS are synced automatically from your sales channel (for specific channels only) or based on your inputs. COGS will be shown in your P&L reflecting the costs of products actually sold (with corresponding decreases to your inventory balance).

You can learn more about how to track COGS in Finaloop under the sales-based method here.

Step 2: Understand the pros & cons of each method

Let's run through the pros and cons and an example to bring this home.

	Purchase-based method 'Record-as-you-buy'	Sales-based method 'Record-as-you-sell'
First, an example: 11/10/22: Purchased 10,000 units of inventory for $1/unit 12/12/22: Sold 5,000 units	11/10/22: Increase COGS by $10,000 (10,000 units x $1 each). No inventory impact. 12/12/22: No COGS or inventory impact. 12/31/22: Increase inventory and reduce COGS by $5,000 (5,000 unsold units x $1 each).	11/10/22: Increase inventory by $10,000 (10,000 units x $1 each). No impact to COGS. 12/12/22: Decrease inventory and increase COGS by $5,000 (5,000 units X $1 each).
Pros	Easy to manage - Everything is automated. Real-time P&L - No waiting on your input for actual COGS.	Better accuracy - Shows a more accurate view of your financial position. Better cost visibility - More insightful gross profit helps you better manage costs.
Cons	Less accurate - No view of your actual gross profit or net income Less cost visibility - you won't know when to reorder or how to better manage your costs	More complex - You’ll need to track COGS separately in order to provide the input. Delayed P&L results - Until you input your COGS each month, your P&L will be incomplete. *In a few months, these numbers will be synced automatically from your sales channels when we drop our new inventory tool.
Best for	Dropshippers or businesses that hold less than $3,000 of inventory each month	Larger brands with inventory balances at month-end >$3,000 or smaller companies that want better insight into their costs.

If you're interested in the sales-based COGS and want to understand more about tracking your inventory costs for your books, check out this blog.

A quick note on cash and accrual inventory tracking for your taxes....

Generally, if you earn income by selling inventory, COGS must be deducted based on sales-based COGS, i.e., accrual basis. With certain exceptions, this rule applies whether you file taxes on a cash basis or an accrual basis.

In other words, even if you file your tax return on a cash basis, your COGS deduction would generally be calculated based on the sales-based COGS, not purchase-based COGS. This is why we adjust your purchase-based COGS at year-end for unsold inventory.

The IRS provides an exception - you can deduct COGS based on purchases (pure cash basis) if you meet certain conditions, including:

You made a special tax election to report inventory on a cash basis, and
You don't actively record the value of your inventory (although inventory count is OK).

To prevent any issues in qualifying for this exception, please confirm with your CPA if an election was made to report inventory on a cash basis under Treas. Reg. §1.471-1(b). If yes, choose the purchase-based COGS to record COGS each month. If no election was made, you can choose to apply either of the methods in your books throughout the year. We will make sure to make any relevant adjustments at year-end to get your numbers tax-ready.