If you're an interested businessman and sell goods, you've most probably heard about "ending inventory" This term explains the total value of products a company still has for sale at the end of an accounting period. It is a piece of vital information for businesses not only for the chance of selling more but also for projecting marketing and sales for the next month, quarter, or year. That's why we mentioned almost all the details of ending inventory, from the description to the benefits, here in this post to help you better understand the topic.
Reading further, you will learn about the ending inventory formula, why it is crucial for businesses of all sizes, and how 3PL companies help improve ending inventory management in detail.
Table of Contents
What Is the Formula to Calculate Ending Inventory?
Ending inventory describes the financial value of your available stock status at the end of an accounting period. This information is vital to appropriately calculate the cost of goods sold (COGS)
and ending inventory balance. Once a given accounting period finishes, you take your beginning inventory, add net purchases and subtract the COGS. The resulting figure shows your ending inventory value. To reach an accurate total, you need to claim all your inventory as an asset initially. Shortly, ending inventory refers to the sellable goods in your warehouse you have leftover at the end of an accounting period. When it comes to knowing how to calculate ending inventory, various methods impact your financial results at the end of the day. Let's start with the first one: the FIFO method.
- FIFO Method (First In, First Out): This term tries to tell you that the first inventory you purchase is sold first. The charge of your first inventory purchases is added to your cost of goods sold before the earlier purchases, which are added to your ending inventory. The logic in this technique is that a company would sell the oldest inventory items first and keep the recent items in inventory to help avoid obsolescence. For example, if purchased 100 products were for $10 and 100 more products were purchased next for $15, FIFO would assign the cost of the first item of $10. After sold 100 items, the new cost of the item would become $15, no matter what was additionally purchased. FIFO technique is generally preferred most on high prices or inflation, as it produces a higher value of ending inventory than any alternative method.
- LIFO Method (Last In, First Out): LIFO is the inventory valuation method opposite to FIFO and tries to tell you that the recent inventory you purchase is sold and shipped out first. In inflationary economies, this results in deflated net income costs and lower ending balances in inventory when compared to FIFO. For example, let's say you bought 5 of one SKU at $15 each and another 5 of the same SKU at $20 each. If you sell five units using the LIFO technique, you will sell the five items you purchased most recently at $20 each and record $100 as the COGS. This method could be helpful during times of decreasing prices.
- Average Weighted Method: This is calculated by dividing the amount you spend on the available inventory by the total number of items on hand. It allows you to see an average of the cost of purchased products in your ending inventory. Say that you've started the year with an opening inventory balance of 100 items at $2.50 each. You purchased an additional 300 items at $3.50 each later on. In the end, you'd have an ending inventory with 400 items valued at $3.25 each and a total value of $1.300.
- Average Cost Inventory: In this technique, all the items in the inventory are charged the same. To calculate the ending inventory using this method, you need to divide the inventory cost by the total number of items ready for sale. It takes you to the result of net income and ending inventory balances between FIFO and LIFO.
- Specific Inventory Tracing: The specific identification inventory valuation method tracks every single inventory item one by one according to its entering and leaving times.
- Gross Profit Method: This is another way of calculating ending inventory value, in which you need to know either the gross profit percentage or the gross margin ratio. With this information on hand, you need to add the cost of beginning inventory and Calculate the estimated cost of goods sold by multiplying by sales in the period. Lastly, subtract the estimated cost of goods sold from the cost of goods available in the first step to get your ending inventory.
- Retail Method: As retailers mostly prefer this, the method is named after them. The retail method uses a close relation between retail price and costs in the past periods. Here how it goes:
- Determine the cost to retail percentage.
- Determine the cost of goods ready for sale.
- Determine the cost of sales during the period you're tracking.
Scale up B2C fulfillment operations with an integrated digital warehouse and fulfillment system
Why Is Ending Inventory Important?
Business people always want to know how much they sell and how much they don't sell. In the e-commerce world, ending inventory is vital for companies to keep an inventory check record, calculate the net income, and maintain accurate future reports. Let's look at each in more detail.
Recorded Inventory vs. Actual Inventory
To have accurate results at the end of the day, you need to control your inventory figures on the papers and those in the warehouse. Your ending inventory value should match the physical inventory you have on hand. If there are fewer inventory levels than they should be, this is most probably a sign of inventory shrinkage stemming from an accounting error, theft, or a series of other reasons.
Just like you want to know your inventory status, you also want to know how much revenue you make on what you sell. To better understand this, you need to calculate your ending inventory and see if your actual inventory matches the recorded one. If the figures don't match up, this could mean that you're paying too much for the initial purchase. Or maybe you should start planning to reshape your pricing strategy.
Accurate Future Reports
While you calculate your ending inventory from the beginning inventory, it could also be vice versa. It can calculate an accounting period's beginning inventory from the last period's ending inventory.
To maintain proper inventory management, ending inventory costs should be calculated accurately to avoid discrepancies in future reports. Therefore it's best to stick with one method that suits your company.
How Do 3PLs Contribute to Ending Inventory Management?
Tracking inventory can sometimes be a short mission to succeed. That's why partnering up with a 3PL company
and benefiting from their technology can help the process be smoother and more effortless. Want to know how?
The Power of Accurate Inventory Tracking
Tech-enabled 3PL companies' tools can help this issue as they are directly integrated with inventory management software businesses. Thus, you have the chance to track inventory from an online dashboard, assisting you to make more accurate decisions when buying and selling goods, give better customer care, and save on inventory and logistics costs. Also, the tasks that are usually time-consuming, like calculating, can be done with just a few clicks, thanks to this technology.
Tailor-Made Reports & Projection
With 3PL companies, it is easy to sync order fulfillment
processes with an inventory management solution. In this way, you can optimize your supply chain and concentrate inventory reporting more correctly. With the tools used by these 3PLs, here are some metrics you can track:
- Best-selling items
- Sales frequency due to channels
- Days left till an SKU will be out of stock
- Historical inventory levels at any point regardless of time and location
- Slowest-moving items
FAQ on Ending Inventory
Here in this part, you can find 3 of the most commonly asked questions regarding ending inventory, a.k.a closing inventory.
What is ending inventory?
Ending inventory refers to the sellable inventory you have leftover at the end of an accounting period.
What is ending inventory on a balance sheet?
Ending inventory is the total unit amount of inventory in stock at the end of an accounting period. The ending inventory figure is needed to derive from the cost of goods sold and the ending inventory balance to include in a company's balance sheet.
How to calculate ending inventory using FIFO?
FIFO is an accounting method that assumes sold the inventory you bought first. In this technique, the cost of your oldest inventory purchases is added to your COGS before your earlier purchases.
Written by Erhan Musaoglu
Erhan Musaoglu is the CEO and Co-Founder of Logiwa.