About
Applies to: Finaloop Core
With purchase-based cost of goods sold (COGS), Finaloop records your inventory purchases as COGS when you buy them, then adjusts your inventory balance once a year so your tax return shows the right closing balance. Finaloop shows this method in your inventory settings as Purchase based. You can also view this video to understand more.
If you're not sure if this is the right method for you, first check out our article How to choose your COGS tracking method in Finaloop.
When you choose purchase based COGS:
Inventory-related purchases are recorded directly as COGS on your P&L, on the date they're received. By default, each purchase is marked as received on its purchase date, so it reaches COGS right away.
Your balance sheet doesn't change during the year, except for purchases you mark as not yet received: those show as inventory in-process or in-transit until they're received.
We make a year-end adjustment to your balance sheet so that the inventory closing balance at year end is correct for filing your tax return.
You can also check out our Purchase-based COGS walkthrough (interactive demo) to learn more.
1. When is purchase based COGS right for you?
The purchase based COGS method is a great choice if you're a brand that:
Sells all products through dropshipping, and vendor invoices are issued on or very close to the date of the customer order or the date when payments to the vendor are made; or
Doesn't hold, on average, more than $3,000 of inventory each month.
2. How to set up purchase based COGS
As a one-time task, we'll need you to enter your inventory closing balance from the previous financial year. This becomes your Finaloop opening balance and ensures consistency year over year. You can get this value from your previous year's balance sheet or from your tax return, if it was already filed.
Here's an example:
12/31/2025 Closing balance (previous books) $2,500
01/01/2026 Opening balance (Finaloop) $2,500
To set your Finaloop opening balance:
In the sidebar, click Inventory, then click Inventory settings (top right) and open the Opening balance tab.
In My inventory balance on (the date shown is the day before your books start), enter the inventory balance from the previous year.
Select the checkbox I qualify for the inventory exception for small business taxpayers and not required to report my inventory balances on my tax return. only if you are sure that you qualify. See Exception for small business taxpayers.
Click Save. You'll see Saved successfully.
① Opening balance tab, ② the My inventory balance on field, ③ the small business taxpayer checkbox.
Adding an opening balance needs an active subscription.
We'll automatically add each inventory purchase to COGS in your P&L once it's received (by default, on the purchase date).
The opening balance you added will be the balance shown as inventory in your Balance Sheet until we make an adjustment for any unsold inventory at the end of the year. To see an example of what your financials will actually look like under purchase based COGS, see How COGS and inventory are reported in your financials.
Note: Use the on-screen FAQs below the field if you need more help: How do I calculate my inventory balance on [date]? and How do I know if I elected to use the "Exception for Small Business Taxpayers"? See also How to find your inventory balance on your tax return.
3. Tracking your inventory purchases
The list of purchases you see on the Inventory page are your inventory-related transactions from your banks or credit cards or from any bills in Finaloop. If relevant, you can also track inventory-related payroll transactions.
To view and track inventory transactions, click Inventory in the sidebar. With purchase based COGS, Inventory is a single page with no tabs.
① Filters, ② Total purchases and the category cards, ③ the purchases list.
The screen has three sections.
Filters on the Inventory page
Filter options:
Period: e.g. today, last month, last quarter etc.
Date range: From and To
Status: In-process, In-transit, Received. The status shown is the status as of the last day of the selected period.
Search: enter text or a value
Inventory totals
Global totals
Total purchases: all inventory purchases made during the selected period. Under purchase-based COGS, these bills and payments are treated directly as COGS.
Category totals
On your screen, you'll only see the relevant categories for your business.
Dropshipping
Finished products
Shipping & freight-in
Supplies & materials
Packaging materials
Production costs
Consignment
Custom fees & services
Dead inventory
Other inventory costs
Production labor costs
Duties & tax
Inventory insurance
Pallet costs
Shipping surcharge
Vendor fees
Product donations
Product giveaways
Warranty reimbursement
Drill down details
Click the category to filter by the purchases for each category.
You can see the inventory categories on the Inventory page when you click the link Learn about purchase categories just below the filters. For how each category is treated, see What happens when you categorize a purchase as inventory or COGS.
Transaction details
① Shipped on, ② Received on, ③ Add split, ④ Source.
Here you can drill into each transaction and see and update further details, such as:
Shipped on and Received on dates. The Received on date is the date the purchase is added to COGS. Use Not shipped yet? or Not received yet? to clear a date.
Split the purchase into 2 or more transactions or shipments with Add split and update the status of each shipment
View the transaction source (e.g., bank/credit card transaction or bill) with the Source link
Upload attachments
Click Save to keep your changes, or Close.
When viewing your transaction details, you can see all your bank/credit card transactions or bills that relate to your inventory categories.
Purchases from bank and credit card transactions
Shown on the Inventory page with the bank transaction source icon. These are transactions from your bank accounts or credit cards that were categorized into an inventory-related account (see the Category totals list of all the inventory categories), either automatically by us or by you.
① The bank transaction source icon.
Purchases from vendor bills
The Inventory page may also have inventory-related purchases from vendor bills. These may have been synced automatically if you are using Settle or Bill.com for your vendor bills, or you may have added them manually on the Bills page. See Managing your bills (payables).
① The bill source icon.
4. Adding or editing missing/uncategorized inventory transactions
You can manually edit or add transactions if you have uncategorized inventory transactions, or if transactions are in the wrong category.
To categorize or change the inventory category:
In the sidebar, click Transactions to recategorize specific transactions.
In the sidebar, click Vendors → Bills to add any missing inventory bills.
5. Exception for small business taxpayers
Normally, the IRS requires any business that sells products or holds inventory to report its cost of goods sold (COGS) on an accrual basis, even if you file your tax return on a cash basis.
That means your COGS is based on what you sold, not what you purchased. This rule prevents businesses from deducting the cost of unsold inventory too early (for example, buying extra stock in December just to reduce taxable income).
There's an IRS exception for small business taxpayers under the regulations of IRC §471 (Treasury Regulation §1.471-1(b)). If you qualify and your books don't track your inventory's value, you can deduct inventory costs when you purchase the inventory, instead of when you sell it.
To qualify, you must:
Have average annual gross receipts for the previous three tax years at or below the small business threshold ($32 million for tax years beginning in 2026; the IRS adjusts it for inflation each year), and
Not actively track the value of your inventory (a physical count of units without tracking their value is fine).
Most businesses that carry inventory do track inventory value, either in Finaloop or elsewhere, so this exception wouldn't apply. But, if you don't track your inventory value and you meet the small business threshold, select the checkbox I qualify for the inventory exception for small business taxpayers and not required to report my inventory balances on my tax return. on the Opening balance tab in Finaloop. Your inventory balance is then set to $0, so no year-end adjustment moves costs out of COGS. If not, we'll make necessary adjustments at year-end by removing the cost of unsold inventory from your COGS to ensure your numbers stay tax-ready and compliant with IRS rules.
Important: If you do not track your inventory value at year end, select the exception checkbox when you set your opening balance. See How to set up purchase based COGS.
6. How COGS and inventory are reported in your financials
Here's an example of how COGS are recorded in the P&L and Balance Sheet using the purchase based method, unless you apply the IRS exemption.
When inventory-related items are purchased and received, COGS in the P&L are increased. You'll find them in Report center → Profit & Loss, under Cost of delivery → Product COGS.
At year end, the inventory line in the Balance Sheet and the COGS in the P&L are adjusted to produce a closing balance using this formula:
Opening balance + inventory purchased - inventory sold = closing balance.
Here's an example. It assumes each purchase is received on the day it's bought. A purchase paid in one month and received in the next adds to COGS in the month it's received.
Date | What happened | P&L impact (COGS $) | Balance Sheet impact (Inventory $) |
Opening balance |
|
| $2,500 |
January 10 | Purchased 2,000 units @ $1 | +$2,000 | No change |
March 22 | Sold 1,000 units | No change | No change |
September 27 | Purchased 2,000 units @ $1 | +$2,000 | No change |
December 31 | Year end adjustment | -$3,000 of unsold units | +$3,000 of unsold units |
Closing balance |
| $1,000 | $5,500 |
For a tour of the report, see Reading your Profit & Loss.
Year-end adjustments
At the year end, we'll ask you for the balance of unsold inventory (in the example with a $2,500 opening balance, it's $5,500) in your inventory year-end checklist.
Go to Year-end Hub (More → Year-end Hub) and, under Inventory, click Go to Inventory. You can also open it from the banner on the Inventory page: [year] Inventory year-end checklist, then Let's go.
Complete each task in the checklist and click Mark as completed: - Review inventory purchases: check that all your inventory purchases (bills and bank transactions) for the year are reported. Go to Purchases page opens them. - Add opening balance, if it appears: confirm your opening balance. - Add closing balance: in Enter your inventory balance on [date], enter the estimated cost of your unsold inventory on that date. If it's insignificant (less than $3,000, as a rule of thumb), you can enter 0.
Check Review and confirm your balances: Opening balance + Purchases - COGS = Closing balance.
Click Submit. The checklist now shows Submitted.
① Review and confirm your balances, ② the Enter your inventory balance on field, ③ Mark as completed, ④ Submit.
We then make the necessary adjustment for tax purposes so that the value of COGS is the value of inventory actually sold, ensuring that you don't overstate the value of COGS in your tax returns.
There's an exception to this general approach for small business taxpayers. See Exception for small business taxpayers.
FAQ
Why did my COGS jump in one month?
Under purchase based COGS, a purchase adds to COGS in the month it's received. A large inventory order received that month raises COGS, even if the products sell over the following months.
Why did my COGS drop in a month when I paid for inventory?
Purchases that are still in-process or in-transit stay on the balance sheet and reach COGS only once they're received. Check the purchase's Received on date on the Inventory page.
Why does December look different?
The year-end adjustment is recorded at the end of the year. It moves the cost of your unsold inventory out of COGS and onto the balance sheet, so December COGS can look very different from other months. It's usually lower when you end the year with more inventory than you started with.
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Need help?
If you have any questions or need assistance, reach out to us at [email protected]. We're here to help make the process as smooth as possible!