A lot goes into owning and operating a winery. There’s the growing or sourcing of grapes and products to resale, the staffing, the branding and marketing, the customer service and more. If you’re managing all that, the last thing you want to think about is accounting. However, as with any industry, proper accounting is an essential part of ensuring you can continue to focus on the parts of the wine business you love.
The single biggest issue we see with our winery clients is undervaluing their inventory. This is especially common for those who grow their own grapes.
Undervaluing inventory usually happens when you account for certain costs associated with producing your end product as expenses, as opposed to considering them in the value of your end product. Because of this common misconception, it results in income statement losses and undervalued assets on the balance sheet.
Why is properly valuing your inventory important?
When your inventory is undervalued, it leads to an overall inaccurate picture of your business financial health. You may run the risk of selling your products for less than cost; have reduced opportunities to access needed funding for business expansion or capital expenditures; all of which impact your ability to generate cash flows in order to achieve your business strategic and financial objectives.
If you’re not considering all the costs of your wine production in the valuation of your inventory, there is no way to determine with certainty how much you need to sell your finished product for. It is essential to account for all the costs of production, from grape growing, to harvest, to wine production, to finishing, in the proper costing of that bottle of wine.
While it may seem simpler to write-off these expenses as you incur them, it skews the true financial results of the business. Generally, profits and the assets of the business will be much lower than they really should be. Lenders are far less likely to provide funding to unprofitable businesses that also report a low asset base. This minimizes your opportunity to access the necessary funding to grow your business.
How to value inventory at your winery
There are several methods for valuing the inventory, including first-in, first-out (FIFO), specific identification, average cost and last-in first-out (LIFO). The most common method is FIFO for items you purchase and resale. The specific identification may be more preferable for wine production wherein you need to track a variety of production costs over the course of more than one reporting cycle.
FIFO assumes that the oldest items in your inventory will be the first to sell. While this may generally be the case with wine shop retail items that you purchase and resell; it may not be the most appropriate method for wine inventories. Most wineries will have products that need to age for varying amounts of time. For example, some wines are produced and sold more quickly than others. While other wines are left to age for a few years before being bottled and ready for sale.
Therefore, specific identification, while it can be complex, is often the most accurate method for managing and valuing the inventory of your winery.
Specific identification requires tracking the cost of production throughout the entire process until it results in a finished bottle of wine.
The cost of tending the vines and growing of grapes includes all costs associated with vineyard management from direct labour, to the nutrients and supplies needed to ensure the grape crop comes to fruition. The following stage involves the harvesting of the crop and all the costs associated with that part of the production. Then there’s the costs associated with winemaking which includes the winemaker and cellar crew labour, additives, lab testing and a variety of other expenses. Lastly, there’s the finishing costs associated with bottling the wine which include the bottling labour, equipment rental, labelling, bottles, corks/capsules and any other process costs necessary before your product hits the shelf.
All of these costs should be accounted for in the costing of your product and ultimately the value of your inventory.
Regardless of which method you use to allocate your costs to your finished product, it is important to use it consistently.
What is accrual accounting and why is it important for wineries?
Accrual accounting refers to the method of matching the expenses to the revenue earned to which the expenses relate in a fiscal year. It means that expenses and revenues are recorded at the time of the transaction, regardless of whether or not money exchanges hands.
For example, you order and receive delivery of wine bottles in December which you plan to use for bottling your wines in the spring. You would record the purchase in your accounting records in December. The cost of the bottles would be captured in your bottle inventory (as an asset) and the bill would either be recorded as accounts payable (if you plan to pay the bill in a subsequent period) or as a reduction to your bank account if you pay for them right away. Similarly, if you sell your wine to a customer on credit, you would record the revenue associated with the wine sold when it leaves your inventory, rather than when they pay your invoice.
Accrual accounting allows for a smoothing of income and expenses (accomplished through the matching principle) and provides an accurate picture of your business short- and long-term financial health.
Tips for managing and valuing your inventory
If the above info seems overwhelming to you, you’re not alone. Inventory management and valuation is complicated and can be confusing.
Here are few tips from our team:
- Invest in specialized software. Our favourite for Canadian wineries is Ekos, but there are a variety of options to explore.
- If you’re a startup, seek help from an accountant early on. If you can set a strong foundation for your accounting right at the start, it will save you a lot of time and effort down the line.
- If you’ve been running your winery for a while, it’s never too late to get help. An experienced accountant can help you work through your books and set you up for continued growth and success.
- When hiring accounting support, look for someone with winery experience. The wine industry has specific requirements when it comes to accounting. Work with someone who has experience in the industry to ensure your business is in good hands and you are getting the right information at the right time.
Need accounting help for your winery?
Our team has extensive experience in the wine industry and can help you navigate your books, accounting, inventory valuation and more. If you’re looking for an accounting firm who can help you grow and thrive, book a free consultation today to learn about how RHN can support you.