Calculating ending inventory is a critical component for any business dealing with physical products. It’s the value of goods that remain unsold at the end of an accounting period.
It is a key figure in determining a company’s cost of goods sold (COGS) and profits for the period. The calculation of ending inventory directly impacts the balance sheet and income statement, and by extension, the financial health of a business.
To accurately assess ending inventory, it’s essential to have a good understanding of inventory basics. Don’t stress, as this post will cover all the different types of inventory – raw materials, work-in-progress, and finished goods – and the flow of inventory through a business.
Additionally, we’ll dive into several inventory valuation methods, such as First-In, First-Out (FIFO), Last-In, First-Out (LIFO), and weighted average cost. So, read on, as we get into the nitty-gritty of all things ending inventory for your eCommerce business.
In this article
Understanding Inventory Basics
Inventory is a critical component of many businesses, concerning the complete stock of goods. This entails raw materials, work-in-process items, and finished goods that companies hold as part of their assets for the intent of resale.
Essential Inventory Terms
Inventory represents a company’s merchandise, raw materials, and finished and unfinished products that have not yet been sold. These are considered assets on a company’s balance sheet. Inventory management is the oversight of non-capitalised assets, or inventory, and stock items. Here’s a quick run-through of a few of these concepts:
- Products: Items that are ready for sale.
- Raw Materials: The basic materials from which products are manufactured.
- Work-in-Process (WIP): Goods that are still in the process of being manufactured.
- Finished Goods: Items that have completed the manufacturing process and are ready to be sold.
A company’s stock levels determine the quantity of inventory available at any given time, which is crucial for meeting customer demand without incurring excess overhead.
Inventory Valuation Overview
Inventory valuation is the accounting process used to calculate the value of a business’s inventory. This involves determining the cost associated with the item at each stage of production.
- Specific Identification Method: Associates costs with an individual item of inventory.
- FIFO: Assumes the oldest items in a company’s inventory have been sold first.
- LIFO: Assumes that the most recent items added to a company’s inventory are sold first.
- Weighted Average Cost: Takes the average cost of all the goods available for sale during the accounting period.
Effective inventory valuation ensures accurate financial statements and plays a significant role in a company’s profitability reporting. It’s an integral element of managing a manufacturing business as it determines the cost of the goods sold and affects both the balance sheet and income statement.
Calculating Ending Inventory
Now that you understand a few of the pivotal terms around closing inventory, we’ll get into why it’s important to calculate ending inventory. To start, businesses employ specific methods to determine the value of unsold stock at the end of an accounting period. This is why making an accurate calculation of ending inventory is crucial for reporting financial health and assessing COGS.
Ending Inventory Formula
Ending inventory is usually worked out by adding the cost of net purchases to the beginning inventory and then minusing the cost of goods sold. The formula can be shown as:
Ending Inventory = Beginning Inventory + Net Purchases – COGS
Where:
- Beginning Inventory is the value of inventory at the start of the period.
- Net Purchases include all inventory purchased during the same period, minus any discounts or returns.
- COGS represents the direct costs attributable to the production of the goods sold by a company.
The final figure represents the ending inventory’s value, using data from the accounting period to reflect the remaining stock.
Applying Cost of Goods Sold
The Cost of Goods Sold is determined by adding the cost of goods available for sale during the period to the beginning inventory and subtracting the ending inventory. COGS is crucial in calculating gross profit and net income. It can be presented as:
COGS = Beginning Inventory + Cost of Goods Available for Sale – Ending Inventory
For clarity:
- Cost of Goods Available for Sale includes all costs ready for sale, which is the sum of beginning inventory and net purchases.
- Gross Profit is derived by subtracting COGS from net sales.
- Net Income is calculated by subtracting expenses, including COGS, from total revenue.
Understanding COGS helps in analyzing how well inventory is managed and its impact on the profitability of a business. This in turn can help you turn unwanted products into income.
Inventory Valuation Methods
In the realm of accounting, inventory valuation methods are crucial for determining the cost of goods sold and ending inventory. Companies can choose from several methods, each affecting financial statements differently.
FIFO Method
The FIFO method assumes that the oldest inventory items are sold first. Under this method, the cost of the newest inventory remains on the balance sheet as ending inventory. During periods of inflation, FIFO results in lower cost of goods sold and higher net income.
- Example Scenario: A company has 300 units bought at different times:
- 100 units at $10 each (Oldest Inventory)
- 200 units at $12 each (Newer Inventory)
When the first 100 units are sold, the cost recorded is the price of the oldest inventory, $10 per unit.
LIFO Method
The LIFO method posits that the most recently acquired inventory is sold first. This leads to a higher cost of goods sold and a lower net income in times of rising prices as it matches current costs with current revenues.
- Example Scenario: For the same company:
- Oldest Inventory: 100 units at $10 each
- Most Recent Inventory: 200 units at $12 each
If the company sells 100 units under LIFO, it records the cost of the newest inventory at $12 per unit, which is higher than FIFO’s cost per unit.
Weighted Average Cost Method
The weighted average cost (WAC) method calculates an average cost per unit by dividing the total cost of goods available for sale by the total number of units available for sale. This method smooths out price fluctuations over the accounting period.
- Calculation:
- Total Cost of Goods Available for Sale: $3,400
- Total Units Available for Sale: 300 units
- Average Cost per Unit: $3,400 / 300 units = $11.33 per unit
When items are sold, the cost of goods sold is determined by multiplying the average cost per unit with the number of units sold.
How We Can Help with Ending Inventory?
At J&J Global Fulfilment, we’ve got various systems in place to help with inventory management. This includes the following:
- Fulfilment software: Our fulfilment software can help with order and warehouse management.
- Inventory management systems: With our data-driven ControlPort™, you can maximise your inventory health.
- Global network of fulfilment centres: With centres in the US, UK, EU, and Australia, we can help you scale your business and get rid of excess inventory.
- Multi-platform integrations: We’re able to integrate with any platform, including TikTok, Shopify, WooCommerce, and Amazon, or connect you your own bespoke solutions using our custom API.
Wrap Up & Key Takeaways
To wrap it all up, you can see why ending inventory calculations and inventory management is important. Understanding your ending inventory balance for an accounting period can make you aware of what inventory purchases are doing well and what aren’t.
Moreover, your ending inventory value can impact how your taxable income does, as well as affecting marketing strategies and your borrowing capacity. Calculating ending inventory can also see what sellable inventory you have. That’s where the ending inventory methods we mentioned, like FIFO and LIFO can come in handy.
Still feeling a bit overwhelmed about the inventory management of your online business? Contact us at J&J Global Fulfilment and we’ll set you on the right path.
Frequently Asked Questions
What is the Formula for Calculating Ending Inventory with the FIFO method?
The FIFO method calculates ending inventory by taking the cost of the most recent items purchased and adding it to the remaining inventory. This assumes that the oldest items are sold first.
How can You Determine Ending Inventory Using the LIFO Accounting Approach?
Ending inventory under the LIFO method is determined by the cost of the oldest inventory items. These are the costs that remain after assuming that the most recently acquired items are sold first.
What Steps are Involved in Calculating Ending Inventory through the Weighted Average Cost Method?
To calculate ending inventory using the weighted average cost method, one must multiply the average cost of all inventory items by the total number of items still available for sale at the end of the period.
How do You Calculate Ending inventory without COGS?
When the COGS is unknown, ending inventory can be estimated using methods such as the gross profit method or retail inventory method which involve using a historical gross margin or a retail price to cost price ratio.
How do You Calculate the Change in Inventory Levels from the Beginning to the End of a Period?
The change in inventory levels is calculated by subtracting the beginning inventory from the ending inventory. If the ending inventory is higher, there’s an increase; if it’s lower, there’s a decrease.
About the Author
