Inventory margins: know what you make on every product

Ask a business owner their overall margin and most can answer. Ask what they make on one specific product and the room goes quiet. That silence is expensive: a blended margin is an average, and averages hide exactly the thing you need to see — which products carry the business and which ones quietly ride along for free.

COGS in one sentence

Under an inventory-based accrual approach, inventory costs are generally recognized in cost of goods sold as the related items are sold. Buying stock can reduce cash before it reduces profit. The federal tax treatment can differ, including exceptions for eligible small businesses; use the accounting method and cost-allocation rules that apply to your business.

The roaster: what a $16 bag actually costs

Consider a fictional coffee roaster selling a 12 oz retail bag and a 5 lb wholesale bag. For this simplified example, assume green beans cost $4.20 a pound and roasting loses 15% of their weight. The figures below cover materials, packaging, and inbound freight only; production labor and overhead still need to be considered.

• Roast loss. Roasting drives off moisture — about 15% of the weight. A pound of roasted coffee therefore costs $4.20 ÷ 0.85 = $4.94, before anything else happens to it.
• The coffee in the bag. A 12 oz bag holds 0.75 lb of roasted coffee: $4.94 × 0.75 = $3.71.
• Packaging. Bag, label, and one-way valve: $0.62.
• Freight in. The shipping you paid to get green beans to the roastery is part of the cost of the beans. Spread across the order it adds $0.17 a bag.

The included costs total about $4.50 per retail bag. At a $16 selling price, that leaves about $11.50 before production labor and overhead, or roughly 72% of sales. For the wholesale bag, $24.71 of coffee plus $1.10 of packaging and $0.55 of freight totals $26.36. At $52, about $25.64 remains before those additional costs, or roughly 49%. These are illustrative partial-cost margins, not final accounting gross margins.

Production labor and allocable overhead are not simply optional categories. IRS Publication 334 explains that manufacturing cost of goods sold can include direct and indirect labor and other production costs. Determine the treatment required by your reporting and tax methods with your accountant, and apply it consistently. A management estimate that omits those costs should be labeled accordingly.

The example shows why the sales mix matters, but the decision needs the remaining production and selling costs too. Wholesale may bring steadier orders and lower selling costs per bag; it may also need more working capital. Compare consistently calculated product margins before choosing where to grow.

When costs move: the average does the remembering

Green coffee doesn’t stay at $4.20. Buy the next lot at $4.65 and the honest cost of “a bag of coffee” shifts. Average costing handles this without heroics: your remaining stock’s cost blends with each new purchase, and every sale carries the average that’s true at that moment. What matters isn’t the method’s name — it’s that the cost travels with the sale automatically, so your February margin reflects February’s bean prices without anyone rebuilding a spreadsheet.

What to do with per-product margins

• Reprice the outliers. A product 20 points below its siblings either earns a higher price, a cheaper input, or a reason — strategic loss-leaders are fine, accidental ones aren’t.
• Chase freight, not just unit price. Freight-in is part of COGS and it’s invisible until you allocate it. Consolidating two shipments into one is a margin improvement no customer ever notices.
• Watch the drift, not just the level. A margin sliding from 72% to 66% over three months is a supplier increase or a discounting habit — and it’s the earliest warning you’ll get.
• Kill or bundle the losers. A product that can’t earn its margin after repricing can still earn its keep in a bundle — or it can stop consuming shelf space and attention.

None of this requires a quarterly spreadsheet project. Tracked inventory posts cost of goods at every sale, which means the per-product view is a report you open, not an analysis you commission. The roaster’s $16 bag was always making $11.50. The only change is that now somebody knows.