Is inventory a current asset or an expense?

Stock you hold is something you own that will turn into cash, so it sits on the balance sheet as an asset. Because it is expected to sell within the year, it is classed as a current asset, alongside cash and money owed to you. The moment a unit sells, its cost leaves inventory and becomes cost of goods sold, matched against the sale it produced.

The example follows the demo store through September. It started the month with 52,300.00 of stock and bought 24,890.40 more, including freight and duty. Those purchases did not touch profit: they went into inventory. Only the 23,190.40 of stock that actually sold moved to cost of goods sold, leaving 54,000.00 still on the shelves as an asset at month end.

The IRS describes the same flow on Schedule C, lines 35 to 42: inventory at the start of the year plus purchases and other costs, less inventory at the end of the year, gives cost of goods sold.^[1]

On a balance sheet, current assets are listed first: cash, then amounts due to you, then inventory, then prepaid costs. Inventory sits there because it is expected to turn into cash within the year. Stock at a 3PL or in an Amazon fulfillment center belongs on the same line as stock in your own warehouse.

At September 30 the demo store held 54,000.00 of stock against 25,634.45 of cash: inventory was 64.4% of its current assets. The store has no customer receivables because marketplaces collect from buyers; the nearest thing is the Amazon reserve, cash Amazon is holding for it. Inventory rose 1,700.00 while cash fell 160.75, which is the balance-sheet view of money moving onto the shelves.

Publication 538 says an inventory is necessary to clearly show income when the production, purchase or sale of merchandise is an income-producing factor, which describes almost every online store.^[2] Inventory includes merchandise or stock in trade, raw materials, work in process, finished products, and supplies that physically become part of the item for sale.^[2]

Two rules matter for sellers:^[2]

• Purchased merchandise is yours once title has passed to you, even if it is still in transit, and goods you have sent out on consignment are still yours.
• Goods you have sold, once title passes to the buyer, goods consigned to you, and goods ordered for future delivery you do not yet have title to are not in your inventory.

Stock in an Amazon fulfillment center or a 3PL is still yours, so it is still inventory: Publication 538 counts merchandise once title has passed to you “even if … you do not have physical possession,” and Amazon's fulfillment terms state that title to units stays with the seller.^[2][4] Publication 538 also says that if you must account for an inventory, you must use an accrual method for your purchases and sales, unless you qualify for the small business exception below.^[2]

Beginning inventory is last period’s ending inventory, carried forward. It is not counted again: the count at the end of one month is the opening figure for the next. Publication 538 says the same for the tax year: for merchandise on hand at the beginning of the tax year, cost means the ending inventory price of the goods.^[2]

For the demo store, beginning inventory for September is the 52,300.00 counted at August 31, and October will open at the 54,000.00 counted at September 30. If you only have the other three figures, rearrange the cost of goods sold formula: beginning inventory = ending inventory + cost of goods sold − purchases, so 54,000.00 + 23,190.40 − 24,890.40 = 52,300.00. A business in its first period starts at zero.

An error in the count carries forward. If ending inventory was overstated last month, this month opens too high and cost of goods sold comes out too high by the same amount. You can run the numbers in the cost of goods sold calculator.

Inventory is carried at what it cost, on the expectation that it will sell for more. When that stops being true, because units are damaged, returned unsellable, out of season or superseded by a new model, the books write the stock down to what it can realistically be sold for, and the reduction is recorded as a loss on the profit and loss in the month it is recognized. Units that are destroyed or cannot be sold at all are written off entirely. Either way the balance sheet stops showing value that is not there.

For tax, Publication 538 has two relevant rules:^[2]

• Lower of cost or market. Under this method you compare the market value of each item on hand on the inventory date with its cost and use the lower of the two. It cannot be used with LIFO.
• Goods that cannot be sold at normal prices, because of damage, imperfections, shop wear, changes of style, odd or broken lots or similar causes, are valued at their bona fide selling price minus the direct cost of disposition, whichever method you use for the rest of your inventory.

How a write-down is treated on your return is a question for your tax preparer. For the books, a monthly review of slow-moving and returned stock keeps the inventory figure honest.

Publication 334 lets a business that qualifies as a small business taxpayer choose not to keep an inventory for tax purposes, treating it instead as non-incidental materials and supplies, or using a method that conforms to its books and records.^[1] The threshold is average annual gross receipts over the 3 prior tax years of $31 million or less for tax years beginning in 2025, or $32 million for 2026, and the business must not be a tax shelter.^[1][3]

Which method suits your return is a question for your tax preparer. For running the business, books that track inventory as an asset are still what tell you your real margin and how much cash is sitting on the shelves.

The common mistake is booking every supplier payment straight to expense. In the demo store's September, that would record 24,890.40 of cost instead of 23,190.40, and profit for the month would be 1,700.00 lower than it really was, exactly the amount stock grew by. In a month where the store sells down its stock, the error runs the other way and profit looks better than it was.

The result is a margin that swings with your buying pattern, not your selling, and a balance sheet that hides how much of your cash is tied up in stock. That is the number you need before placing the next order. The full calculation is in how to work out cost of goods sold, and the cost of each unit is built up in landed cost.

If you sell on eBay and have never counted stock held at a warehouse or 3PL, or your supplier payments go straight to expenses, our eBay seller bookkeeping keeps inventory on the balance sheet at landed cost, counts every location, and moves cost to cost of goods sold as units sell, so your margin and your cash position are both right each month.