Five Inventory Accounting Pitfalls I See Small Businesses Make (and How I Help Them Avoid Them)

If you sell products—whether online, in a storefront, or through wholesale, you already know how critical inventory is to your business. What you might not realize is how quietly bad inventory accounting can erode your profits.

As a CPA, I've worked with plenty of small business owners who thought they had inventory handled, until these mistakes came back to haunt them. Let me walk you through five of the most common pitfalls I see and the practical steps I help clients take to avoid them before they cause real damage.

1. Overlooking "Landed Costs" Like Shipping and Tariffs

It's easy to record what you paid for your products and stop there. But if you're leaving out freight-in, import duties, packaging, warehouse labor, and handling fees, you're not seeing the full picture.

When those costs aren't included in your inventory value, your Cost of Goods Sold (COGS) is understated. Margins look healthier than they really are, and that can lead to bad pricing and purchasing decisions.

Here's what I recommend: Build landed costs into your accounting workflows from day one. If it's required to get your product ready for sale, it belongs in the inventory cost, no exceptions. I help clients create simple tracking systems that capture these costs automatically, so nothing gets missed.

2. Holding on to Obsolete or Unsellable Inventory

It happens to everyone: you over-order, trends shift, or a batch goes bad. When outdated or unsellable inventory stays on the books at full value, your balance sheet is overstated—and you're not getting a realistic view of your business.

Accounting rules say those items need to be written down to their net realizable value. Doing that sooner rather than later reflects the lost value in the right period, instead of when the item is finally sold or disposed of.

The fix is simpler than you think: Review inventory at least quarterly and mark down anything expired, damaged, or unsellable at full price. Make it part of your closing checklist and looping sales, operations, and accounting so no one's caught off guard. I've seen this single change save businesses from major year-end surprises.

3. Using the Wrong Inventory Method

FIFO, LIFO, average cost… these aren't just technical accounting terms. They directly affect your income statement and your taxes.

Many small businesses default to FIFO because it's common, but it isn't always the best fit. But making that change isn't trivial—the IRS treats it as a change in accounting principle, which means extra filings and potential complications.

My approach with clients: We evaluate which method matches your industry, pricing trends, and cash flow goals before you get locked into something that doesn't serve you. If it's time for a change, we handle it properly to stay compliant with the IRS and avoid headaches down the road.

4. Not Reconciling Physical Inventory With the Books

One of the fastest ways inventory gets out of control is when the books say one thing, and the warehouse says another. If your system shows 200 units but you only have 150, you end up with inaccurate financials, missed sales, poor purchasing decisions—and potential tax issues.

What works: Schedule regular cycle counts or full physical inventory checks, then reconcile variances immediately and adjust the books accordingly. If it makes sense for your operation, invest in an inventory management system that syncs in real time so you're always working with accurate data. The peace of mind alone is worth it.

5. Treating Inventory Like an Expense Instead of an Asset

This one trips up a lot of newer business owners. Recording inventory purchases directly to COGS as soon as you buy them might feel intuitive, but it distorts your margins and your taxes.

Under proper accounting, inventory stays on the books as an asset until it's sold, that's when it hits your P&L as COGS.

The right way: Record purchases to an inventory asset account and only recognize COGS when a sale occurs. It keeps your financials cleaner and gives you a much clearer view of actual profitability. This is fundamental, but I'm surprised how many businesses get it wrong.

Your margins are only as accurate as your inventory accounting. Whether you're running a retail storefront, a Shopify shop, or a B2B wholesale operation, getting these five areas right makes all the difference. The good news? Every one of these pitfalls can be fixed with the right systems, the right setup, and a little accountability along the way.

At Dark Horse CPAs, managing inventory the right way is just one part of how we support growing businesses. From day-to-day bookkeeping to strategic Fractional CFO services, we help business owners build clean, reliable financials that actually drive better decisions. Our team works with companies across a wide range of industries, combining tax strategy and accounting expertise to meet you where you are in your business journey.

I’d love to hear more about your business and where you want to take it. If you’d like to talk through how we can strengthen your accounting function, you can book a time on my calendar let’s see how we can start adding value to your business.

About Dark Horse CPAs

Dark Horse CPAs provides an integrated suite of services including tax, accounting, fractional CFO, and wealth management to small businesses and individuals across the U.S. The firm was established to transform the client experience by offering personalized, high-quality services that small businesses and individuals deserve. As Dark Horses in their industries, these businesses benefit from advanced tax strategies and accounting insights typically reserved for larger companies. With a nationwide presence and a team of dedicated professionals, Dark Horse CPAs is committed to your success. Get a quote today.