Cost of Goods Sold and Inventory for Online Sellers

A growing number of online sellers hit a confusing point each year: their accountant tells them they made a healthy profit, yet their bank account tells a different story. The explanation is almost always the same. Cash that went into buying more stock is sitting in inventory, not in your current account, but HMRC counts it as profit until the stock is sold.

This page explains how cost of goods sold works, how closing stock is valued, and why the cash-versus-profit gap is a structural feature of a growing stock-based business, not an accounting error.

The short answer: only sold stock reduces your profit this year

Under accruals accounting, your taxable profit is your revenue minus the cost of goods you actually sold, not the cost of goods you bought. Stock you purchased but still hold at your year end is an asset, not an expense. If you reinvested every pound of margin back into new inventory, your taxable profit for the year can be many times higher than your bank balance. That is the mechanism. Buying more stock before your year end does not cut your tax bill; it just converts one asset (cash) into another (stock).

Whether this applies to you depends on which accounting basis you use. Cash basis is the default for unincorporated businesses, and the treatment of stock purchases under cash basis differs. For stock-heavy sellers, accruals plus proper inventory tracking almost always gives better decision data and smoother taxable profits. The choice is covered in detail in our cash vs accruals guide; this page assumes accruals unless stated otherwise.

What COGS means in seller terms

Cost of goods sold is the cost of the stock you sold during the year, calculated as:

COGS = Opening stock + Purchases during the year − Closing stock

Opening stock is the value of inventory you held at the start of the period. Purchases are everything you bought during the year. Closing stock is what you still hold unsold at the end. The difference is what you sold.

This formula is why closing stock matters so much. The higher your closing stock value, the lower your COGS, and the higher your gross profit. Get the closing stock number wrong and your entire profit figure is wrong.

Worked example: why buying more stock does not cut your tax bill this year

Take a seller with the following numbers for the year:

The seller bought £70,000 of stock during the year. But because £28,000 of it is still on hand, only £50,000 flows through to COGS. The remaining £28,000 is an asset. Gross profit is £70,000, even though the bank balance is much lower after paying suppliers and operating costs.

Now compare what would have happened if the same seller had bought an extra £15,000 of stock in the last week of the year, rushing to cut their tax bill:

Gross profit is identical. Buying more stock that is still unsold at year end moves cash into a different asset; it does not create a deduction. The only way buying stock reduces this year's profit is if you actually sell it before your year end.

Valuing closing stock: lower of cost and net realisable value

HMRC BIM33115 requires closing stock to be valued at the lower of cost and net realisable value (NRV) under accruals accounting.

Cost is what you paid to acquire the goods and get them to their current location and condition (see landed cost below).

Net realisable value is the expected selling price, less any further costs you still need to incur before or at the point of sale. For a standard FBA line, NRV is roughly your expected sale price less platform fees and any costs of getting the goods to the customer.

The lower-of-cost-and-NRV rule means:

• If stock is selling normally and NRV is above cost, you value it at cost.
• If stock is distressed, discontinued or marked down and NRV has fallen below cost, you must write it down to NRV. You cannot carry slow-moving stock at cost if you know you will sell it for less.

Writing stock down to NRV is not optional; overstating closing stock understates COGS and overstates profit, which HMRC treats as an error.

On the method used to determine which specific units make up closing stock (FIFO, weighted average, specific identification), no single method is mandated by UK tax law. Different cost-flow assumptions are permitted; the point is that whatever method you use must be consistent and must arrive at cost per unit accurately. If you are uncertain which approach suits your business, this is worth discussing with an adviser.

What counts in cost: the landed-cost principle

The cost you use for stock valuation should reflect what it actually cost to get the goods to their current location and condition ready for sale. For an ecommerce seller importing goods from overseas, this typically includes:

• The purchase price paid to your supplier
• Import duty paid at the UK border
• Inbound freight and shipping costs to bring goods to your warehouse or prep centre
• Customs clearance and brokerage fees, where directly attributable to the goods

Outbound postage and fulfilment costs (sending goods to your customers) are selling expenses, not part of the inventory cost. They sit below gross profit, not inside COGS.

Keep records that let you reconstruct the landed cost per unit. If you import container loads with mixed SKUs, you will need an allocation method for shared freight and duty. The principle is consistent attribution, not precision to four decimal places.

The cash-versus-profit gap: what to do about it

If your business is growing and you are reinvesting margin back into stock, a persistent gap between taxable profit and bank balance is normal. The gap is not a problem in itself; it is evidence that your business is funding its own growth. The practical issue is managing the cash outflow when your tax bill arrives.

Three habits help:

1. Set aside tax as you go. Once you have a rough sense of your gross margin, allocate a percentage of each month's revenue to a tax reserve. This prevents the year-end bill from arriving as a surprise against a depleted bank balance.
2. Track closing stock quarterly, not just annually. Running a quarterly stock count lets you project your tax position before year end, so you can plan cashflow rather than react to it.
3. Time stock buys around your actual sales cycle, not around your tax year end. Buying stock in December because your year end is December achieves nothing if it stays unsold; it just defers the cash outflow. Plan stock buys to match demand.

If your settlement payouts from Amazon, Shopify or eBay do not reconcile neatly to the revenue and COGS figures your accounts show, that is a bookkeeping problem first and a tax risk second. Our settlement payout reconciliation service works through the platform-level data to get the numbers right before they reach your accounts.

Where your accounting basis comes in

Everything above assumes accruals accounting, which requires you to match costs to the period in which you sold the goods. Under cash basis, the default for unincorporated businesses, the treatment of stock can differ. The choice matters enormously for a stock-heavy seller, and the right answer depends on your turnover, growth stage and whether you are incorporated.

The full comparison, including when accruals is worth electing and what the switch entails, is in our cash vs accruals for stock businesses guide. Do not decide on the basis of one article; the interaction with your year-end stock value can be significant either way.

Common failure modes

The errors that cause the most trouble at tax time tend to cluster around three habits:

Expensing all stock when purchased

Some sellers record every supplier invoice as an immediate cost. This works under cash basis but is incorrect under accruals. Under accruals, the purchase goes into inventory first; only the sold portion becomes COGS at the period end. Expensing all purchases immediately understates closing stock and artificially reduces profit in the short term, creating a distorted picture that catches up painfully.

Ignoring closing stock entirely

Not counting closing stock at all means your COGS figure is just "purchases," with no adjustment for what you still hold. For a growing seller with significant inventory, this can understate profit dramatically in one year and then overstate it the next as stock is sold. HMRC can and does challenge accounts where closing stock is absent or implausibly low.

Confusing cash out with a tax deduction

Writing a cheque to a supplier is not the same as claiming a tax deduction. Under accruals, the deduction happens when you sell the goods. Sellers who believe they "already paid tax" on stock they bought, or that paying suppliers reduces their tax bill in real time, are operating on a cash-basis mental model inside an accruals system. The two must match.

For a seller moving from spreadsheets to proper bookkeeping, or from cash basis to accruals, the Amazon sellers and Shopify sellers sections cover the setup considerations specific to each platform. You can also model your true take-home margin after COGS, fees and tax using our seller take-home calculator.