How Inventory Management Can Lower Your Taxable Income

In these uncertain economic times, it seems like the odds are completely stacked against small businesses. There is certainly a lot that any startup must overcome, but there are also creative (and legal) ways to ensure that your business' tax liability is lessened. Inventory management can play a key role in ensuring you don't pay a cent more than you have to.

The Last In-First Out inventory management system has been popular in the United States since the 1970s when the recession in 1973 brought the economy into uncertainty. Under this system, the most recently produced goods are written off the books as the first ones sold. In a time of economic uncertainty, this system makes sense because it will lower the gross profit without affecting the real cash flow.

To further illustrate this, let's run through an example that assumes inflation. Let's assume your company purchases raw materials and creates 1000 widgets with a product cost of $10 per widget in March. Because of the rising prices, in April the cost to make 1000 widgets is $20 and in May, $30. Yep, these are pretty brutal times we're living in. But with the LIFO system, those 1000 widgets, which were produced for $30,000 in May are written off first so that on the income statement inventory is now lower by $30,000 rather than the $10,000 that would have been removed under the First In-First Out system. This lowers the overall gross profit.

There are many ways to ensure you are not overpaying your taxes so keep an eye out for helpful tricks. Because of the delicate legal nature of some accounting practices, a CPA should be consulted before making any changes to accounting methodology. There is also tax software available from companies like Orbisoft and Intuit, which can help you with your accounting practices.

* Guest post by Margot McClelland

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