Ending inventory refers to the value of your goods at the end of your accounting period. It’s the difference between your COGS and your beginning inventory. If you’re responsible for managing your own inventory, it’s essential to know how to calculate ending inventory and why it’s used in financial reports. In this blog, we’ll explain ending inventory calculation
What is ending inventory?
If a business carries inventory, it will need to determine its ending inventory. Ending inventory is simply what’s leftover after all products have been sold and paid for. It may sound simple, but understanding ending inventory can be difficult.
Whether you’re calculating it by hand or using software like QuickBooks or Excel, there are several metrics you’ll need before you can figure out your total ending inventory. You’ll need to know your sales volume, per-unit costs, and calculation method. Using this information and some basic math skills, you can quickly figure out your ending inventory amount.
Calculating beginning inventory
Your beginning inventory is your last period’s ending inventory for the financial year.
Beginning Inventory = COGS + Ending Inventory – Net Purchases.
COGS
COGS equals the total cost of purchasing or manufacturing goods ready to be sold for a given accounting period.
Formula to calculate COGS = Opening Inventory + Purchases – Closing Inventory.
Why is calculating ending inventory essential?
To calculate ending inventory, you need to know what it is. In short, ending inventory equals goods on hand at a company’s balance sheet date. That value will be included under current assets as inventory on a balance sheet.
This number is also used to calculate the COGS to determine how much it costs for a company to sell its goods and services. Having high amounts of inventory can lead businesses into debt when they do not sell all their products. If that’s the case, they might not be able to replenish their stocks, which results in losses in sales revenue. Having too much product can also lead to theft or spoilage.
How do you calculate ending inventory?
Ending inventory can be tricky because it varies based on how you define it. Most businesses and accountants use FIFO (first in, first out), LIFO (last in, first out), or weighted average.
Weighted average is a bit more flexible than other methods, and it helps keep things simple because you can order each category at different times throughout the year and balance them accordingly.
FIFO
First In First Out, also known as FIFO, is the most commonly-used method for calculating ending inventory. It most accurately reflects the COGS, which is essential for financial and tax reporting. To calculate ending inventory using the FIFO method, you take the first units purchased and add it to the cost of the units purchased later. This gives you the total cost of all the units on hand at the end of the period.
If you have a lot of units, you can use a spreadsheet to track the cost of each unit purchased. Or, if you prefer, there are many online FIFO calculators that can do the work for you.
LIFO
Calculating ending inventory using the LIFO (Last In, First Out) method accurately reflects the COGS. To calculate ending inventory using the LIFO method, you will need the following information:
- The cost of goods ready for sale.
- The COGS.
With this information, you can easily calculate ending inventory using the LIFO method by subtracting the cost of sold goods from the cost of available goods for sale. Let’s look at an example to see how this works.
Example:
The XYZ Company has the following information available for June:
- Cost of goods ready for sale: $100,000,
- COGS: $80,000.
To calculate ending inventory using the LIFO method, we subtract the COGS from the cost of goods available for sale. In this case, that would give us an ending inventory figure of $20,000.
Average weighted method
If you’re using the average weighted method to calculate ending inventory, you’ll need to take the average cost of all the units you purchased. To do this, add together the total cost of all the units you purchased during the financial year and divide that by the total value of units you purchased. This will give you your average unit cost.
Once you have your average unit cost, multiply it by the number of units in your ending inventory. This will give you your total cost of goods available for sale. To get your ending inventory value, subtract your total COGS from your total cost of goods available for sale.
It’s important to note that the average weighted method only works if you use a perpetual inventory system. If you use periodic inventory system software, you may not get an accurate calculation of your ending inventory using this method.
Gross profit method
If you are a business owner, determining the value of your ending inventory is crucial to understanding your company’s financial health. The ending inventory value is used to calculate your COGS, which is a key component in determining your gross profit.
You can use several methods to calculate your ending inventory, but the most common method is the gross profit method. This method considers your sales and COGS to determine the value of your ending inventory.
To calculate your ending inventory using the gross profit method, you will need to determine your total sales for the period. Then, you will need to calculate your COGS for the period. To complete this, it is essential to know the cost of every product sold during the last financial year.
Once you have this required information, you can calculate your ending inventory using the following formula:
Ending inventory = Total Sales – Cost of Goods Sold
Retail method
The retail method is a popular choice for calculating ending inventory because it accounts for both the COGS and the selling price of the merchandise. Take the total sales for the period and subtract the COGS to use this method. This will give you your ending inventory value.
There are a few things to keep in mind when using the retail method. First, you need to have accurate sales data. This means that all returns and discounts need to be accounted for. Secondly, it’s important to know the selling price of all products in inventory. This can be tricky if you sell products with different price points, or if you offer discounts throughout the year.
If you have good data and can accurately calculate your sales and costs, the retail method is a fast and convenient way to estimate your ending inventory.
Why do you need to calculate ending inventory?
Ending inventory is an important aspect of your business because it provides insight into your inventory purchases and sales. This information helps you determine whether or not you need to place new orders with your supplier and dictates how much cash you should have in hand at all times.
If there’s too much inventory left over at the end of the year, customers are buying less than you planned for. It may also indicate an error in the counting or ordering of products.
Accurate inventory count
To get an accurate inventory count, you need to consider all items you have in stock. This includes finished products, raw materials, and those that are a work in progress. It would also help if you counted everything on your shelves, backroom, and warehouse. Once you have a complete count of your entire inventory, you can begin calculating your ending inventory.
Calculate net income
If you want to calculate your company’s net income, you need to know how to calculate ending inventory. Inventory is a key factor in determining a company’s net income. To calculate inventory, businesses either use the perpetual or periodic system. The perpetual system records inventory constantly, while the periodic system records it at specific intervals.
It’s essential to keep the cost flow assumption in mind while calculating inventory. This assumption determines how the costs of goods sold are assigned to ending inventory. The three cost flow assumptions are FIFO, LIFO, and weighted average cost (WAC).
Calculating ending inventory is relatively simple once you’ve determined which cost flow assumption you’re using. You’ll need to know your beginning inventory levels, and then do the following:
- Determine the COGS.
- Add purchases made during the period.
- Subtract any returns or allowances.
This will give you your ending inventory level for the period. From there, you can calculate your company’s net income.
How does calculating ending inventory help your business?
Ending inventory is one of your most important financial measures as a business owner. It’s also among one of the more mysterious. Some people treat it like it’s a salary, and others will tell you that it doesn’t exist at all. In fact, calculating ending inventory can be very tricky, depending on what you sell and how you account for sales.
At its core, though, your end of period inventory is what was sold during a given period, and what has been reordered or manufactured since then. More importantly, these two measures give you real insight into your business performance. For that reason alone, they shouldn’t be overlooked.
Determining COGS
To calculate ending inventory, you need to figure out your COGS. A shortcut for determining this is by adding your beginning inventory to your purchases, and then subtracting ending inventory. This can often be used as a quick way to account for these numbers without digging through several years of records. If you’re on QuickBooks or another accounting software, it will give you accurate totals instantly.
Calculating net income
If a company generates more income than it spends, it will have net income. Likewise, if a company spends more money than it takes in, it will have a net loss. To determine how much a company keeps after covering costs, simply subtract expenses from revenue.
Matching inventory records with purchase records
Once you have your ending inventory amount, it’s time to match your ending inventory numbers with your purchase records. Add up all your purchases and subtract that number from your total COGS. This difference will tell you how much inventory is left over at the end of an accounting period. If you don’t already have these records available in another spreadsheet or software program, now is an excellent time to start tracking them.
Checking your pricing strategy
Your pricing strategy dictates how much you charge for each product unit. There are three common strategies to consider: cost-based, value-based, and competition-based. When determining your pricing strategy, it’s important to be familiar with all three to make an informed decision about which one will work best for your business model.
Calculating taxes
You have to pay certain taxes and dues on your net income each year. When it’s tax time, you have to add up your total earnings for the year and calculate how much money you owe. A major component of your income is calculated through inventory. If you sell items that must be kept on hand until sold, tracking ending inventory becomes essential.
Improve inventory management with DEAR Systems
There are many steps to calculating ending inventory. Although there can be a high level of subjectivity when making these calculations, you should understand the two most popular calculation methods and how to accurately find your ending inventory.
While it may take some time to learn and implement these techniques, you should now understand how essential ending inventory is. We hope you feel more confident and prepared when you audit or prepare financial statements for yourself at the end of the year. Plus, you can always reach out to us if you have any questions or concerns.
Using DEAR Systems, you can get accurate and real-time visibility of your inventory levels. You can also automate your inventory purchases to avoid stockouts. All this would lead to better inventory tracking and ease your inventory calculation process. If you’re interested in trying out DEAR Systems for your business, schedule a demo with our experts now.
