If you sell physical products, inventory is likely your largest asset and your most significant expense. It is also where the most consequential accounting mistakes happen. The gap between how founders think about inventory and how it should be accounted for is wide. The consequences show up in misleading margins, confused investors, and painful restatements.
These are the mistakes that come up again and again.
Mistake #1: Expensing Inventory on Purchase
The most fundamental error is treating inventory purchases as an immediate expense. When you write a $50,000 check to your co-manufacturer, that money did not disappear. It transformed from cash into another asset: inventory.
Under proper accrual accounting, inventory sits on your balance sheet as an asset until it is sold. When a unit sells, the cost of that unit moves from the balance sheet to the income statement as cost of goods sold (COGS). This matching principle, recognizing the cost in the same period as the revenue it generated, is the foundation of accurate margin reporting.
When you expense inventory on purchase instead:
- Your P&L in the purchase month shows an artificially high expense with no corresponding revenue
- Your P&L in the selling months shows revenue with no COGS, making margins look impossibly good
- Your balance sheet understates your assets, because inventory is not tracked there
- Your gross margin percentage is meaningless, because costs and revenues are not aligned
Mistake #2: Ignoring Landed Costs
The price your co-manufacturer charges per unit is not your true cost of inventory. Landed cost includes every expense required to get that product from the manufacturer to your warehouse shelf, ready to sell:
- Freight and shipping from manufacturer to your 3PL or warehouse
- Customs duties and import tariffs if manufacturing overseas
- Insurance during transit
- Warehousing receiving fees charged by your 3PL for inbounding product
- Quality inspection costs if applicable
A DTC brand that records inventory at the manufacturer's invoice price and expenses freight separately is understating their true cost of goods. That $12.00 unit from the co-packer might actually cost $14.50 when you include freight, duties, and receiving fees. Across thousands of units, that $2.50 gap materially distorts your gross margin.
The fix: All costs required to get inventory to a sellable state should be capitalized into inventory cost, not expensed separately. Your per-unit cost should reflect the true landed cost.
Mistake #3: Never Writing Down Inventory
Products expire. Trends change. Formulations get updated. Yet many startups carry old, unsellable inventory on their balance sheet at full cost indefinitely.
Under GAAP, inventory must be carried at the lower of cost or net realizable value. If you have product that:
- Has passed its expiration date
- Is damaged or defective
- Is from a discontinued SKU that will not sell at full price
- Can only be sold at a steep discount below cost
Then that inventory needs to be written down to its realistic recoverable value, or written off entirely if it is worthless. Failing to do this overstates your assets and delays recognizing a real economic loss.
The brands that handle this well establish a regular inventory review process, quarterly at minimum. They age their inventory, identify slow-moving SKUs, and make informed decisions about markdowns, donations, or write-offs. The brands that do not handle it well discover they have $200,000 of expired product on their balance sheet during due diligence.
Mistake #4: Choosing the Wrong Costing Method
There are three primary methods for valuing inventory and calculating COGS:
- FIFO (First In, First Out): Assumes the oldest inventory is sold first. Most common for CPG because it reflects the physical reality. You ship the oldest product first to manage shelf life.
- LIFO (Last In, First Out): Assumes the newest inventory is sold first. Rarely used in CPG and not permitted under IFRS.
- Weighted Average Cost: Averages the cost of all available units. Simpler to calculate but less precise than FIFO.
For most CPG brands, FIFO is the right choice. It aligns with how you actually manage physical inventory, and it provides the most accurate matching of costs to revenue when input costs are changing over time.
The mistake is not just picking the wrong method. It is not picking one at all, or applying it inconsistently. Your costing method affects your:
- Gross margin per unit and in aggregate
- Balance sheet inventory valuation
- Tax liability in some cases
- Comparability with industry benchmarks
Pick a method, apply it consistently, and document your choice. Changing methods later requires disclosure and can create confusion for investors reviewing historical trends.
Mistake #5: Not Tracking Inventory by SKU and Location
Knowing your total inventory value is not enough. You need visibility into:
- Inventory by SKU: Which products are moving and which are sitting? What is your margin by product line?
- Inventory by location: How much is at your 3PL, in transit, at Amazon FBA, or on consignment with a retailer?
- Inventory by lot or batch: This is critical for products with expiration dates or for tracing quality issues.
Without this granularity, you cannot make informed decisions about purchasing, discontinuation, or channel strategy. You also cannot perform accurate inventory reconciliation, matching what your books say you have to what is physically in your warehouse.
Discrepancies between book inventory and physical inventory are normal in small amounts. When they are large and unexplained, it signals a broken process. Investors and auditors will flag it.
Why This All Matters for Fundraising
Investors evaluating a CPG brand look closely at three things that are directly impacted by inventory accounting:
- Gross margin. Is it real, or is it distorted by improperly matched costs? Are landed costs fully capitalized?
- Working capital. How much cash is tied up in inventory? Is inventory turning efficiently or sitting for months?
- Asset quality. Is the inventory on the balance sheet actually sellable, or is it inflated with obsolete product?
A well-run inventory accounting process answers all three questions clearly. A poorly run one raises doubts about every number on your financial statements.
The time to get inventory accounting right is before investors start asking questions. Not while they are waiting for answers.