A shop owner who counts the money in the till but never values the stock does not really know whether the business is making a profit. Stock is cash that has been turned into goods, and the cost of the goods you sell is the biggest expense you have. The method you use to value stock affects your profit, your tax and the decisions you make. For a small shop, the weighted average cost method is the simplest to use and explain.

Why valuation matters

Imagine you buy 100 bags of flour at KES 145 and later another 100 at KES 155. When you sell a bag, what did it cost you? The answer changes your profit on that sale. Without a rule, you will use different figures on different days and your profit will be unreliable. A consistent rule also helps when you apply for a loan or answer a question from KRA about your margins.

The average cost method

With weighted average cost, you recalculate the average cost per unit every time you buy. The formula is simple:

Average cost = total cost of stock bought ÷ total units bought

Each sale is then valued at the current average cost. Because the average is recalculated, a rise or fall in supplier prices is smoothed out.

A worked example

Start with an opening purchase of 200 bags at KES 145. The stock cost is KES 29,000 and the average cost is KES 145. You sell 60 bags, so the cost of sales is 60 × 145 = KES 8,700 and 140 bags remain.

Then you buy another 100 bags at KES 152, costing KES 15,200. The total cost of purchases is 29,000 + 15,200 = KES 44,200 for 300 bags, so the new average is about KES 147.33. If you then sell 90 bags, the cost of sales is 90 × 147.33 = about KES 13,260. The ledger tracks all of this automatically. The weighted average stock ledger records purchases and sales for each item and shows the average cost, the stock on hand and the cost of sales.

What other methods exist

FIFO, first in first out, assumes the oldest stock is sold first, and it is common for perishable goods. LIFO is not generally accepted for accounts under international standards. The average cost method sits in the middle and is easy to follow. Choose one method and use it consistently; changing method every year makes your results hard to compare.

Count your stock

A ledger tells you what you should have, and a physical count tells you what you do have. Count regularly, monthly for fast-moving goods and at least once a year for everything. Compare the count with the ledger, investigate differences and record adjustments for losses, damage and theft. Daily cash-up and stock control for a small shop and inventory management basics cover counts and controls.

Use the numbers

Once you know your average cost, you can set prices with confidence. Add your margin and your costs, then check the result with the pricing and markup calculator or the break-even and pricing calculator. Our guide to how to price your products and services in Kenya shows how cost and margin fit together, and the product profitability analyser compares your products by profit.

Stock and tax

Closing stock affects your profit for the year, and so your tax. Cost of sales is deducted from sales to get gross profit, so an overvalued closing stock overstates profit and an undervalued one understates it. Keep supplier invoices to support your costs; how to keep business records for KRA explains the standard. If you are on turnover tax, which is charged on sales, the valuation matters less for tax but still matters for managing the business; see turnover tax for small businesses.

Common mistakes

  • Valuing stock at the selling price instead of the cost.
  • Forgetting transport and handling costs when buying.
  • Not recording damaged or expired goods.
  • Mixing items of different sizes or grades in one line.

Make it routine

Update the ledger the same day you receive or sell stock, and reconcile it with a count each month. After a few months you will see which items earn the most and which tie up cash. That knowledge is worth far more than the small effort of keeping the record.