You ordered $200,000 of inventory from China in November. It shipped in December but will not arrive at your warehouse until January. Is it inventory at December 31?
Maybe. The answer depends on when you took ownership of the product. Ecommerce goods in transit are easy to miss because they are not sitting in your warehouse when you count inventory. However, if you own the product, it may still belong on your balance sheet.
This issue becomes more important as an ecommerce business grows. At any given time, you may have inventory at a supplier, on a ship, sitting at a port, in customs or moving to a fulfillment center. None of those locations necessarily tells us who owns the inventory.
When Does the Inventory Become Yours?
Physical possession does not determine ownership. Instead, we need to look at the agreement with your supplier and the shipping terms.
You may see terms such as FOB shipping point or FOB destination. With FOB shipping point, ownership generally transfers when the supplier ships the product. With FOB destination, ownership generally transfers when the product reaches the agreed destination.
The terminology can get more complicated with international suppliers. The important point is not to memorize shipping terms. You need to know when your agreement says ownership and risk transfer to you.
Once you own the product, we need to consider whether it belongs in your inventory.
Your Physical Inventory Count May Not Be Enough
We recommend periodic physical inventory counts for our ecommerce clients. However, a physical count only tells us what is sitting in the locations being counted.
It does not tell us about the $200,000 of product sitting on a ship that you already own.
That is why we also look at open purchases and shipments around the inventory date. Supplier invoices, shipping documents and purchase agreements can help identify ecommerce goods in transit that should be included in inventory.
For a growing seller, the difference can be significant.
Goods in Transit Can Affect Your Gross Margin
Inventory ultimately affects cost of goods sold. Therefore, inventory errors can also affect gross margin.
If purchases are expensed too early, cost of goods sold may be too high. If inventory you own is missing from the balance sheet, your assets may be understated.
Either way, you are making decisions with bad information.
Ecommerce owners use gross margin to make decisions about pricing, advertising and purchasing. If the inventory number is wrong, those decisions become harder to make.
Don’t Forget the Full Cost of the Inventory
The supplier invoice may not represent the full cost of your inventory.
Freight, tariffs, customs duties and other costs may need to be included in the landed cost of the product. We discussed this in more detail in our article on ecommerce landed cost.
This is especially important for imported products. A product that costs $20 from the supplier may cost $26 by the time it is ready to sell. Your accounting should reflect the real cost.
Know What You Own at Year-End
Goods in transit usually get the most attention at year-end. That is when we need to determine what inventory the business actually owns, not simply what happens to be sitting in the warehouse on December 31.
For smaller ecommerce businesses, the adjustment may not be significant. For a growing seller with several large shipments moving at the same time, it can materially change the balance sheet.
The concept is pretty simple. If you own the inventory, we need to account for it. The fact that it happens to be sitting on a ship somewhere in the Pacific does not make it disappear.