How to Account for Stock and Inventory in Xero

Managing stock and inventory accurately is one of the most common challenges for product-based businesses. This article explains how to account for stock and inventory in Xero, covering tracked inventory items, cost of goods sold, adjustments, and what to do when Xero’s built-in tools reach their limits. Whether you run a retail shop, an e-commerce business, or a trade that buys and sells physical goods, this guide gives you a clear, practical walkthrough.

• What Xero can do with stock and inventory
• Tracked versus untracked inventory items
• Setting up an inventory item in Xero
• How cost of goods sold works in Xero
• Recording stock purchases and receiving inventory
• Making stock adjustments in Xero
• Stock at year end and your annual accounts
• When Xero’s inventory tools are not enough
• Frequently asked questions

What Xero can do with stock and inventory

Xero includes basic inventory management as part of its standard subscription. It lets you create inventory items, track quantities on hand, and automatically post cost of goods sold entries when you make a sale. This works well for businesses with a straightforward product range and moderate stock volumes.

Xero is not a dedicated warehouse management system. It does not handle batch tracking, serial numbers, landed costs, or multi-location stock natively. If your business needs those features, you will need an add-on app integrated with Xero — more on that later.

For many small UK businesses, though, Xero’s built-in inventory tools are perfectly adequate. The key is setting things up correctly from the start so your accounts reflect reality.

Tracked versus untracked inventory items

When you create an item in Xero, you choose whether to track it as inventory or not. This is an important decision because it affects how transactions are posted.

Tracked inventory items

A tracked item has a quantity on hand that Xero monitors. Every time you raise a purchase order or bill for the item, Xero increases the stock quantity. Every time you invoice a customer for it, Xero reduces the quantity and posts a cost of goods sold entry. The stock sits on your balance sheet as a current asset until it is sold.

Untracked items

An untracked item is simply a product or service code you use on invoices and bills. Xero does not monitor quantities. There is no stock asset on the balance sheet. The cost goes straight to a purchase or expense account when you enter the bill.

Use tracked inventory when you need to know how many units you have at any point and when the value of unsold stock is material enough to appear on your balance sheet. Use untracked items for services, one-off purchases, or low-value consumables where tracking is not worth the effort.

Setting up an inventory item in Xero

Follow these steps to create a tracked inventory item in Xero:

1. Go to Inventory in the main menu (or Products and Services depending on your Xero version).
2. Click New Item.
3. Enter the item code, name, and description.
4. Tick I track this item.
5. Enter the purchase price and select the purchase account — this should be an inventory or stock asset account, not a direct expense account.
6. Enter the sales price and select the sales account — typically your revenue or sales account.
7. Set the cost of goods sold account — Xero will post to this automatically when you invoice.
8. Set the correct VAT rate for both buying and selling the item.
9. Save the item.

If you are new to setting up Xero for your business, Xero training can save you a significant amount of time and prevent errors that are awkward to unpick later.

Choosing the right accounts

The inventory asset account sits on your balance sheet under current assets. It holds the cost of stock you own but have not yet sold. The cost of goods sold account sits on your profit and loss. Xero moves value from the balance sheet to the profit and loss when a sale is invoiced. Getting these accounts right from the start is essential for accurate management accounts.

How cost of goods sold works in Xero

Xero uses the weighted average cost method to calculate cost of goods sold. This means it averages out the cost of all units in stock each time you receive a new delivery at a different price.

Here is a simple example. You buy 10 units at £5 each. Your average cost is £5. You then buy another 10 units at £7 each. Your average cost becomes £6. When you sell a unit, Xero posts £6 to cost of goods sold, not the original purchase price.

This matters for your gross profit figures. If your purchase costs fluctuate, your cost of goods sold will reflect blended prices rather than specific lot costs. For businesses where the exact cost of each unit is important — wine merchants or antique dealers, for example — Xero’s weighted average approach may not be appropriate without supplementary records.

Recording stock purchases and receiving inventory

There are two main ways to record incoming stock in Xero.

Using purchase orders

Raise a purchase order in Xero for each stock delivery. When the goods arrive, mark the purchase order as received. This updates the quantity on hand immediately. When the supplier invoice arrives, you convert the purchase order to a bill and approve it. This posts the cost to your inventory asset account.

Using bills directly

If you do not use purchase orders, enter a bill when you receive the supplier invoice. Select the tracked inventory item on the bill line. Xero will update the quantity on hand and post the cost to the inventory asset account when you approve the bill.

Either method works. Purchase orders give you a better audit trail and help you spot discrepancies between what was ordered, what was received, and what was invoiced. For businesses with a higher volume of stock purchases, using purchase orders is worth the extra step.

VAT on stock purchases

Make sure you apply the correct VAT treatment when entering stock bills. If your business is VAT registered, the VAT on purchases is reclaimed on your VAT returns. The inventory asset on your balance sheet should reflect the net cost, not the VAT-inclusive amount.

Making stock adjustments in Xero

Stock counts rarely match system records perfectly. Goods get damaged, miscounted, stolen, or used internally. Xero lets you make manual inventory adjustments to correct the quantity on hand.

To make an adjustment, go to the item in your inventory list and select Adjust Quantity. Enter the new quantity or the adjustment amount. Xero will ask you to select an account for the adjustment — typically a cost of goods sold account or a separate stock write-off or shrinkage account.

Keep a record of why you made each adjustment. HMRC may ask about write-downs and write-offs, particularly if they are significant relative to your turnover. A simple note or spreadsheet log is sufficient.

Stocktakes and reconciliation

Carry out a stocktake at least once a year, ideally at your accounting year end. Count every item and compare the physical count to Xero’s system quantity. Make any adjustments before your accountant prepares your annual accounts. The closing stock figure on your balance sheet must reflect what you actually own.

More frequent mini-counts — perhaps monthly for fast-moving lines — will catch errors earlier and make the year-end process much smoother.

Stock at year end and your annual accounts

At the end of your financial year, the value of unsold stock appears on your balance sheet as a current asset. This figure directly affects your taxable profit. Higher closing stock means lower cost of goods sold for the year, which means higher profit. Lower closing stock means higher cost of goods sold and lower profit.

Stock must be valued at the lower of cost or net realisable value. Net realisable value is what you can actually sell the goods for, minus any costs to complete and sell them. If stock has become obsolete, damaged, or is selling for less than it cost you, you must write it down to the lower figure. Do not carry stock on your balance sheet at a value higher than you can recover from selling it.

Your accountant will need the closing stock figure confirmed before they can finalise your accounts. If you use Xero’s tracked inventory correctly throughout the year, the inventory asset balance in Xero will be their starting point. They may ask for your stocktake records to verify the figure.

For limited companies, the closing stock figure feeds into the corporation tax computation. Getting it right is not optional.

When Xero’s inventory tools are not enough

Xero’s built-in inventory works well for businesses with a manageable number of product lines and straightforward buying and selling. It starts to show its limits in several situations:

• High volume or complex stock: If you have hundreds of SKUs, multiple warehouses, or need to pick and pack from different locations, a dedicated inventory app will serve you better.
• Batch or serial number tracking: Xero does not track individual batches or serial numbers. If you need traceability — common in food, pharmaceuticals, or electronics — you need an add-on.
• Manufacturing: If you assemble finished goods from components, Xero cannot handle bills of materials natively.
• Landed costs: Xero does not allocate shipping, duty, or freight costs to individual stock items. The weighted average cost will not include those figures unless you manually adjust purchase prices.

Popular inventory add-ons that integrate with Xero include Cin7 Omni, DEAR Inventory (now Cin7 Core), Unleashed, and Tradegecko. Each syncs with Xero so that your accounting entries are posted automatically, while the inventory detail is managed in the specialist app. A good bookkeeping setup will define clearly which system holds the master data and how reconciliation works between the two.

E-commerce sellers

If you sell through Shopify, Amazon, eBay, or other platforms, you will likely need a middleware app to handle stock sync and order importing. Xero alone is not designed to import thousands of sales lines from a marketplace and match them against stock movements. Specialist e-commerce accounting support can help you build a system that actually works at scale.

Construction and trade businesses

Businesses in the construction sector often hold materials rather than finished goods for resale. The accounting treatment is similar — materials sit on the balance sheet until used — but the practical workflow tends to differ. Job costing tools within Xero or through add-ons like WorkflowMax can help you allocate material costs to individual projects.

The right setup depends on your business model. Take advice before committing to a particular workflow, because unpicking a poorly configured inventory system is time-consuming and disruptive.

Getting your stock accounting right

Stock and inventory accounting in Xero is not complicated when it is set up correctly. Use tracked items for anything with meaningful value or quantity that needs monitoring. Keep your purchase workflow consistent — whether you use purchase orders or bills directly. Carry out regular stocktakes and reconcile your physical count to Xero. At year end, make sure your closing stock figure is accurate and reflects the lower of cost or net realisable value.

If your stock requirements go beyond what Xero handles natively, there are solid add-ons available. The important thing is to choose a setup that matches how your business actually operates, then keep it maintained. Clean stock records make for clean accounts, accurate tax returns, and better business decisions.

Frequently asked questions

Does Xero track stock automatically?

Yes, for items you have set up as tracked inventory. When you approve a bill or purchase order for a tracked item, Xero increases the quantity on hand. When you approve an invoice for that item, Xero reduces the quantity and posts a cost of goods sold entry automatically. You do need to set the item up correctly in the first place.

What valuation method does Xero use for inventory?

Xero uses the weighted average cost method. Each time you receive stock at a new price, Xero recalculates the average cost per unit across all units held. This average cost is used when posting cost of goods sold on a sale. Xero does not support FIFO or specific identification natively.

How do I write off obsolete or damaged stock in Xero?

Go to the inventory item and use the Adjust Quantity function. Reduce the quantity to reflect the write-off and select an appropriate account — either cost of goods sold or a dedicated stock write-off account. Record the reason for the adjustment. At year end, your accountant will want to see any significant write-offs supported by a note or inventory review.

Can Xero handle stock across multiple locations?

Not natively. Xero holds a single quantity on hand per item with no location breakdown. If you hold stock across multiple warehouses, shops, or sites, you will need an inventory add-on that supports multi-location tracking and syncs the totals back to Xero.

Do I need to do a stocktake if I use Xero’s tracked inventory?

Yes. Xero’s system quantity is only as accurate as the data entered into it. Returns, damaged goods, theft, and data entry errors all create discrepancies over time. A physical stocktake at least once a year — and ideally more frequently for fast-moving lines — lets you verify and correct the system quantity before your year-end accounts are prepared.

Is stock an allowable expense for tax purposes?

Stock is not deducted as an expense when you buy it. It sits on the balance sheet until it is sold, at which point the cost moves to your profit and loss as cost of goods sold. Only the cost of goods actually sold in the accounting period reduces your taxable profit. Unsold stock at year end remains on the balance sheet as a current asset.