Inventory Write-Downs for E-commerce Founders: When to Act and How to Record

What Is an Inventory Write-Down? A Guide for E-commerce Founders

For an e-commerce startup, inventory is often the single largest asset on your balance sheet. But those boxes sitting in a warehouse or 3PL facility represent tied-up cash. When products stop selling, they do not just gather dust; they actively burn runway through storage fees and represent an inflated value in your financial statements. This is not just a physical problem, it is a financial one waiting to happen. A surprise, large-scale adjustment can distort your gross margins, erode investor confidence, and create a sudden, painful hit to profitability. The key is not just knowing how to account for obsolete inventory, but building a system to see the problem coming long before it becomes a crisis.

An inventory write-down is a formal accounting adjustment that reduces the value of inventory on your books. It is the process of acknowledging that certain products are no longer worth the price you originally paid for them. This is not an optional step; it is a core requirement of standard accounting principles. According to the rules, "Accounting rules (GAAP and IFRS) require inventory to be valued at either its original cost or its current market value, whichever is lower." This is often called the principle of conservatism.

For most startups, this principle is applied using the Lower of Cost or Net Realizable Value (LCNRV) method. In fact, "LCNRV (Lower of Cost or Net Realizable Value) is the common valuation method for startups using FIFO/Average cost methods." Net Realizable Value (NRV) is the estimated selling price you could get for the goods, minus any costs necessary to complete the sale, like shipping, marketplace commissions, or minor repairs. Getting this right is fundamental. An accurate inventory valuation ensures your balance sheet is correct, your Cost of Goods Sold (COGS) is not understated, and your gross margin reflects reality. This directly impacts strategic decisions about pricing, purchasing, and even fundraising, as it provides a true picture of your company’s financial health.

When to Act: How to Identify Obsolete Inventory Early

The most common challenge in handling unsellable goods is detecting obsolete or slow-moving SKUs before they become a major financial drag. The shift from a 'gut feeling' about bad stock to a data-informed view is essential for managing the stock impairment process proactively and reducing inventory losses. A systematic approach prevents year-end surprises and keeps your financial reporting accurate.

Use an Inventory Aging Report

The single most effective tool for this is an inventory aging report. You do not need sophisticated software; a spreadsheet exported from your inventory system or Shopify will work. It provides a clear, objective look at which products are not moving by categorizing your stock into age buckets. A typical report should track these key data points for each SKU:

• SKU and Description
• Units on Hand
• Cost Per Unit and Total Cost
• Total Cost broken down by age: 0-90 days, 91-180 days, and 180+ days

For example, imagine your report shows two products. The first, SKU HOODIE-BLACK-L, has 500 units at a total cost of $12,500, all of which is in the 0-90 day bucket. This is healthy. The second, SKU TSHIRT-SAGE-M, has 200 units at a total cost of $3,000. Of this, $750 is 91-180 days old, and $2,250 is over 180 days old. This report immediately highlights the sage t-shirt as a problem area. As a rule, "A key red flag is inventory sitting for over 180 days or a full sales cycle." Items in that 180+ day column are your primary candidates for a write-down review.

Monitor Your Inventory Turnover Ratio

Another key metric to monitor is inventory turnover. This ratio tells you how many times your company sells and replaces its inventory over a specific period. A consistently decreasing turnover rate is a clear warning sign that stock is becoming stagnant and may require an inventory adjustment entry. The formula is "Inventory Turnover formula: Cost of Goods Sold / Average Inventory." While the ideal ratio varies by industry, a downward trend is a universal signal to investigate which specific SKUs are slowing down your overall performance.

Establish a Quarterly Review Cadence

What founders find actually works is establishing a quarterly review. Instead of a year-end panic, a scheduled quarterly check-in makes the process manageable and predictable. This cadence allows for smaller, more regular write-downs, preventing the kind of surprise hits to your financials that can worry investors or breach lender covenants. This meeting should involve finance, operations, and marketing to discuss the aging report, identify problem SKUs, and decide on a course of action, whether it is a clearance sale, a bundle promotion, or a write-down.

How to Account for Obsolete Inventory: Calculation and Journal Entries

Once you have identified at-risk inventory, the next step is to correctly calculate and record the write-down. This structured, three-step process ensures your records are accurate, auditable, and compliant with accounting standards. Following these mechanics is crucial for maintaining the integrity of your financial statements.

Step 1: Calculate Net Realizable Value (NRV)

For each SKU you have identified as a candidate for a write-down, you must first determine its NRV. This is its realistic selling price less any direct costs required to sell it. Be objective. This is not the original retail price, but what you could genuinely get for it today through a clearance sale, a liquidation partner, or a marketplace. Costs to sell could include payment processing fees, pick-and-pack fees, sales commissions, or targeted marketing spend for the clearance event.

Step 2: Calculate the Write-Down Amount

With the NRV established, calculating the write-down is straightforward. The formula is "Write-Down Amount formula: Original Cost - Net Realizable Value." You apply this calculation to every unit of the affected SKU to find the total adjustment needed.

Let’s walk through a numerical example with our problem SKU:

• Product: SKU TSHIRT-SAGE-M from the aging report.
• Units on Hand: 200.
• Original Cost per Unit: $15.00 (Total Book Value = $3,000).
• Situation: This color is out of season and has had minimal sales for over seven months. You decide to put it on a final clearance sale.
• Estimated Selling Price: $12.00 per unit.
• Costs to Sell: $2.00 per unit (for payment processing and fulfillment).
• Net Realizable Value (NRV) per Unit: $12.00 - $2.00 = $10.00.
• Write-Down per Unit: $15.00 (Original Cost) - $10.00 (NRV) = $5.00.
• Total Write-Down Amount: 200 units x $5.00/unit = $1,000.00.

Step 3: Record the Inventory Adjustment Entry

The final step is to record this adjustment in your accounting system. For US companies using QuickBooks or UK companies using Xero, this is typically done via a manual journal entry. This entry formally recognizes the loss on your income statement and reduces the asset value on your balance sheet. According to accounting standards, the "Journal Entry to record a write-down: Debit Cost of Goods Sold (or 'Loss on Inventory Write-Down'); Credit Inventory."

Here is how the entry would look in your accounting software:

• Debit: Cost of Goods Sold for $1,000.00.
• Credit: Inventory for $1,000.00.

You should also include a clear memo, such as, "To write down 200 units of SKU TSHIRT-SAGE-M to NRV of $10.00/unit." This entry increases your COGS, which in turn reduces your gross profit and net income for the period. It also correctly reduces the inventory asset on your balance sheet from its original value of $3,000 to its new, realistic value of $2,000. Documenting the 'why' is crucial for your records, especially for an audit or due diligence.

Creating a System for End-of-Life Product Write-Offs

The reality for most startups is more pragmatic: you do not need a complex system for end-of-life product write-offs. You need a simple, documented policy that you can execute consistently using tools like QuickBooks or Xero and a spreadsheet. A clear policy removes ambiguity and ensures your inventory valuation methods are applied the same way each quarter, which is key for reliable financial reporting.

Your policy should establish clear, rule-based thresholds for action. This turns the 'when' into a systematic decision rather than a subjective judgment call. For example, a simple and effective policy could state:

• "A sample write-down policy threshold is to review SKUs with no sales in 6 months for a partial write-down."
• "A sample policy is to fully reserve (write down to zero) SKUs with no sales in 12 months."

This framework provides a clear mandate for your quarterly review. You run the aging report and apply these rules. For SKUs in the 6-12 month bucket, you calculate the NRV and perform a partial write-down. For SKUs over 12 months with no prospect of sale, you write them down completely, assuming an NRV of zero if they are truly unsellable goods. Combining this policy with regular cycle counts to ensure physical stock matches book quantities creates a robust control environment.

This systematic approach ensures compliance with both US GAAP and international standards like IFRS or FRS 102 in the UK. The underlying principle of valuing inventory at its true current worth is the same across these frameworks. The goal is to make handling obsolete inventory a routine financial task, not a year-end emergency. Consistency is more important than complexity.

Practical Steps for E-commerce Founders

Translating theory into practice requires a few simple, repeatable actions. For an e-commerce founder juggling a dozen priorities, building a manageable system for inventory valuation is critical for maintaining financial discipline and protecting your runway.

First, make your inventory aging report easily accessible. If your platform does not generate one automatically, set up a simple export-to-spreadsheet process. Automate as much of this data gathering as possible so it does not become a barrier to action.

Second, schedule the review. Put a recurring 90-minute meeting on your calendar for the first week of every new quarter. This ensures the task does not get pushed aside by more immediate demands. Consistency here prevents large, unexpected write-downs that can disrupt your financial planning.

Third, document everything meticulously. When you create an inventory adjustment entry, attach your aging report and NRV calculation directly to the journal entry in QuickBooks or Xero. This creates a clear audit trail and makes it easy to explain the adjustment to investors, auditors, or lenders. For businesses in the UK, be aware that HMRC guidance outlines specific rules regarding VAT on lost, damaged, or destroyed goods.

Finally, remember that a write-down is a financial signal that should trigger an operational response. It is a powerful data point for your purchasing and marketing teams. The process of how to account for obsolete inventory is not just about cleaning up the books; it is a feedback loop for smarter purchasing and better cash management. This discipline is essential for reducing inventory losses and protecting your runway. To dive deeper, visit the Inventory & Fulfilment Cost Accounting hub.

Frequently Asked Questions

Q: What is the difference between an inventory write-down and a write-off?
A: An inventory write-down reduces the value of an item that still has some worth (its NRV). A write-off, or full reserve, reduces its value to zero because it is considered completely worthless and unsellable. A write-down is a partial reduction, while a write-off is a total elimination of value.

Q: Can an inventory write-down be reversed?
A: Under US GAAP, an inventory write-down cannot be reversed if the market value of the inventory later recovers. However, under IFRS, a write-down can be reversed up to the amount of the original write-down if there is clear evidence of an increase in the net realizable value.

Q: How do inventory write-downs affect my taxes?
A: An inventory write-down increases your Cost of Goods Sold (COGS), which reduces your reported gross profit and taxable income for the period. This typically results in a lower tax liability. However, tax regulations can be specific, so it is always best to consult with a tax advisor to ensure compliance.

Q: What should I physically do with inventory after writing it down?
A: After a write-down, you should still attempt to sell the inventory at its reduced price. If it is fully written off, you might consider donating it for a potential tax benefit, liquidating it in a bulk sale to a third party, or responsibly recycling or disposing of it if it cannot be sold or donated.