YEAR-END STOCKTAKE
Year-End Inventory Count: How to Do a Physical Inventory Count Step by Step
The stock on your shelves on December 31 sets your cost of goods sold, and so your taxable profit for the whole year. This guide covers the plan from six weeks out, the cutoff rules, a count sheet you can copy, how to reconcile and value the count, and a calculator for shrinkage and COGS.
WHY IT MATTERS
Why the December 31 inventory number matters
If you sell products, you don't deduct everything you bought this year. You deduct the cost of what you sold, and the year-end count is how you find it. Schedule C, Part III, works it out like this:
Cost of goods sold = beginning inventory + purchases + labor, materials and other costs − ending inventory
Your ending inventory this year becomes next year's beginning inventory, so a mistake carries over and moves profit from one year into the next.
That makes the count a profit number, not just a stock number. Every $1,000 of stock you count that isn't really there lowers cost of goods sold by $1,000 and adds $1,000 of profit you'll pay tax on. Every $1,000 you miss does the opposite. The IRS is direct about it in Publication 538: "You must take a physical inventory at reasonable intervals and the book amount for inventory must be adjusted to agree with the actual inventory."
A small online shop closing 2026
The shop started the year with $8,000 of stock at cost, bought $42,000 more and paid $1,500 in freight-in and packaging that becomes part of the product. Its records say $11,200 should be on the shelves. The physical count finds $11,000.
Using the count, cost of goods sold is $40,500. Using the book figure without counting, it would be $40,300, and the shop would report $200 of profit that is really missing stock. The gap is the shrinkage: 1.8% of the book value.
- Beginning inventory
- $8,000 last year's count
- Purchases + other costs
- $43,500 $42,000 + $1,500
- Book ending inventory
- $11,200 what records say
- Counted ending inventory
- $11,000 physical count at cost
- Cost of goods sold
- $40,500 $51,500 − $11,000
- Shrinkage
- 1.8% ($11,200 − $11,000) ÷ $11,200
TIMELINE
Timeline: from six weeks out to count day
A count goes well when most of the work happens before anyone picks up a clipboard. For a December 31 year end, start in mid-November.
Pick the date and clean the item list
Choose a count date as close to December 31 as you can: the last day of business, or the first morning of January before anything ships. Merge duplicate SKUs, retire items you no longer sell, and make sure every item has one unit of measure (each, box of 12, meter) and a current unit cost.
Organize the space
Label shelves and bins as zones. Put every product where it belongs, consolidate half-empty boxes, and move damaged, returned and expired stock into one clearly marked area so it's counted separately. Process supplier receipts and customer returns that are sitting on the floor.
Set the cutoff and print the sheets
Decide the exact cutoff moment (for example, 6 p.m. on December 31): orders shipped before it are sales, deliveries received before it are inventory. Print count sheets or numbered tags per zone and assign counters, ideally in pairs.
Freeze movement
Stop receiving, ship what you can, and keep anything that arrives late in a separate "received after cutoff" spot. If you sell online, pause listings or hold orders for the hours you count.
Count every zone once, then check
Work zone by zone in a fixed path, left to right and top to bottom. Record quantities, not guesses. Then spot-check: a second person recounts a sample of items and every high-value item.
Reconcile, value and post
Compare counts with the books, recount the big differences, value the final quantities at cost, and post one adjusting entry so your books match the count. Save the signed sheets with your year-end records.
CUTOFF
What counts as inventory on December 31
Per IRS Publication 538, inventory includes merchandise, raw materials, work in process, finished products, and supplies that physically become part of what you sell. Office supplies, tools, equipment and shipping supplies that don't become part of the product are not inventory. The hard cases are goods that are moving at year end, and the rule is ownership (title), not location:
| Situation on December 31 | Include in your count? | Why |
|---|---|---|
| Order shipped to a customer on Dec 30 | No | Sold; title has passed to the buyer. Record the sale in 2026. |
| Supplier delivery received Dec 31, invoice arrives in January | Yes | It's yours and on hand. Record the purchase in 2026 too, or COGS will be off. |
| Purchase in transit, title passed when shipped | Yes | The IRS includes purchased goods once title has passed, even in transit. Check the shipping terms on the order. |
| Your products on consignment at another shop | Yes | Still yours until sold. Ask the shop for a count. |
| Another maker's goods consigned to you | No | Not yours. Count them on a separate sheet so they don't slip in. |
| Stock at a market booth or showroom | Yes | Goods held for sale away from your place of business are still inventory. |
| Damaged or out-of-season stock | Yes, separately | Count it, but value it at what it can realistically sell for (see valuation below). |
Fulfillment centers count too: units at Amazon FBA, Shopify Fulfillment Network or a 3PL are your inventory. Download their inventory report as of December 31 rather than estimating.
COUNT SHEET
Inventory count sheet: the columns you need
A count sheet works on paper, a tablet or a spreadsheet. Keep one row per item per location, so an item stored in two places appears twice and gets added up later.
| Column | What goes in it | Filled in |
|---|---|---|
| Zone / location | Shelf, bin or room code, e.g. B-03 | Before the count |
| SKU and description | Your item code and a short name | Before the count |
| Unit of measure | Each, pack of 6, roll, kg | Before the count |
| Count 1 | Quantity found by the first counter | Count day |
| Count 2 | Recount for high-value items or big variances | Count day |
| Condition | Good / damaged / obsolete | Count day |
| Counter initials | Who counted, so questions go to the right person | Count day |
| Book quantity | What your records say should be there | After the count |
| Variance | Final count − book quantity | After the count |
| Unit cost and extended value | Cost per unit × final count | After the count |
Hide the book quantity
Leave the Book quantity column off the sheet counters use. When people see the expected number, they tend to "find" it. Add it only when the sheet comes back.
Number every tag or sheet
In a large stockroom, stick a numbered tag on each counted item group. Log which numbers were issued, used and voided, so you know no sheet or tag is missing before you total.
COUNT DAY
Count day rules
- ✓Nothing movesNo shipping, receiving or restocking in a zone while it's being counted.
- ✓Count in pairsOne person counts and one writes, or two count independently and compare.
- ✓Open the boxesDon't trust labels on opened or resealed cases; count the units inside.
- ✓Mark what's donePut a sticker or chalk mark on each shelf when it's counted, so nothing is counted twice.
- ✓Ink, not pencilCross out and initial corrections; don't erase. It keeps the sheet credible later.
- ✓Count before you totalCollect every sheet and check tag numbers before anyone looks at dollar values.
RECONCILE
Reconcile the count and find your shrinkage
Put the final count next to the book quantity for each item. Most rows will match or be off by a unit or two. Recount anything over your threshold, for example a difference over 5% of the item or over $50 at cost, before you accept it. Common causes when a difference survives the recount:
- Receipts or returns that were never entered, or entered twice.
- Unit-of-measure mix-ups: a "case of 12" recorded as 12 cases.
- Sales recorded under the wrong SKU or variant.
- Damage, samples, giveaways and personal use that weren't written off.
- Theft, which is real but usually not the only cause.
Shrinkage % = (book inventory − physical inventory) ÷ book inventory
Measure it in dollars at cost, not units, so a missing $200 item weighs more than a missing $2 one. For context, the National Retail Federation's 2023 security survey put average US retail shrink at 1.6% of sales for fiscal 2022; that's a sales-based measure from large retailers, so treat it as a rough guide, not a target.
Once you trust the numbers, adjust your books so inventory equals the count. The difference goes to cost of goods sold (or a separate "inventory shrinkage" line under COGS if you want to watch it). Per Publication 538, theft or casualty losses of inventory are normally reflected through that higher cost of goods sold; don't also deduct the same loss again as a casualty or theft loss.
VALUATION
Value the count: what each item cost you
The count gives quantities; the books need dollars. Multiply each final quantity by its unit cost. Publication 538 says cost for purchased goods is the invoice price minus discounts, plus freight and other charges to acquire them. Then decide which purchases those units came from:
FIFO
Assumes you sold the oldest units first, so units left on December 31 carry your most recent costs. The common choice for small sellers.
Specific identification
Match each unit to its actual invoice. Practical for one-of-a-kind or high-value items such as vintage pieces, jewelry or equipment for resale.
Average cost
Many inventory apps and spreadsheets use a weighted average cost per SKU. If you use it for tax purposes, confirm with your preparer that it fits your method, and use it consistently every year.
Whatever you choose, the IRS expects the same method every year. Switching methods generally needs Form 3115, so this isn't a year-end experiment.
YOUR NUMBERS
Inventory shrinkage and COGS calculator
TRY IT
What did the count change?
Enter values at cost for the year. Nothing you type is saved or sent anywhere.
KEEP SCORE
Keeping inventory in Excel or Google Sheets
The count is far easier when your books already know what should be on the shelf. That's what an inventory spreadsheet is for: an item list (SKU, name, unit cost, reorder level) plus a log of every purchase, sale, return and write-off. On-hand quantity is simply everything that came in minus everything that went out, so on count day the book quantity column fills itself.
With items in an Items sheet and movements in a Moves sheet (column A = SKU, column C = quantity in as positive and out as negative), these formulas work in both Excel and Google Sheets. The count sheet columns are A SKU, B description, C location, D count 1, E count 2, F final count, G book quantity, H variance, I unit cost and J extended value.
| Column on the count sheet | Formula (row 2) |
|---|---|
| Book quantity | =SUMIFS(Moves!$C:$C,Moves!$A:$A,A2) |
| Final count | =IF(E2<>"",E2,D2) (count 2 if there is one, else count 1) |
| Variance (units) | =F2-G2 |
| Extended value at cost | =F2*I2 |
| Flag for recount | =IF(AND(G2<>0,ABS(H2)/G2>5%),"RECOUNT","") |
| Shrinkage % (total) | =(SUMPRODUCT(G2:G500,I2:I500)-SUM(J2:J500))/SUMPRODUCT(G2:G500,I2:I500) |
The inventory total then feeds your year-end close. Our year-end bookkeeping checklist covers the rest of closing 2026, and if you sell on Etsy, how much Etsy takes per sale shows how fees eat into the margin your COGS produces.
Counts only reconcile if sales are recorded the same way all year. An order tracking spreadsheet logs every customer order with its status, ship-by date and profit, so units sold can be checked against the stock you counted.
READY-MADE TEMPLATE
Want the stock levels tracked all year?
You can build the sheet above yourself. If you'd rather start with products, purchases and sales already connected, there's a ready-made inventory tracker for Excel and Google Sheets. Check the product page for current features.
Inventory Tracker Spreadsheet Template for Google Sheets & Excel
The current listing describes product records with name, SKU, quantity, purchase cost and sale price, minimum stock levels that flag when to reorder, a log of sales and purchase transactions, and automatic profit and margin per item.
- Stock on hand per product
- Reorder alerts from minimum levels
- Profit and margin per item
Product features and compatibility are listed on the product page and may change.
Browse small business templatesFAQ
Year-end inventory count questions
When should I do a year-end inventory count?
As close to the last day of your tax year as possible: December 31 after closing, or first thing on January 1 before any stock moves. If you count a few days earlier, record every sale and receipt between the count and December 31 so you can roll the count forward.
Is a physical inventory count required for taxes?
If you keep inventories for tax purposes, IRS Publication 538 says you must take a physical inventory at reasonable intervals and adjust your book inventory to agree with it. Small businesses that qualify under the gross receipts test can use simpler methods, but still need reliable records of what they hold.
How do I calculate inventory shrinkage?
Subtract the physical inventory from the book inventory, both at cost, and divide by the book inventory. With $11,200 in the books and $11,000 counted, shrinkage is $200, or 1.8%.
What is the difference between a physical count and cycle counting?
A physical count checks everything at once, usually at year end. Cycle counting checks a small group of items on a rolling schedule through the year. Many small businesses do both: cycle counts for fast or valuable items, plus one full count at year end.
Do I count inventory at a fulfillment center or 3PL?
Yes. Stock you own is inventory wherever it sits. Use the fulfillment provider's inventory report dated December 31 and add it to your own count.
How is ending inventory used to calculate cost of goods sold?
Cost of goods sold equals beginning inventory plus purchases and other product costs, minus ending inventory. A higher ending inventory means lower cost of goods sold and higher profit, which is why an accurate count matters for your tax return.
Sources and further reading
- IRS Publication 538, Accounting Periods and Methods: Inventories
- IRS Publication 334 (2025), Tax Guide for Small Business: Inventories and Cost of Goods Sold
- IRS Form 1125-A, Cost of Goods Sold (for corporations and partnerships)
- National Retail Federation: National Retail Security Survey
Checked October 9, 2026. The $31 million gross receipts figure is the one printed in Publication 334 for 2025 returns and is indexed for inflation each year. Examples are illustrative, not tax or accounting advice.
