It should be noted that while the numbers you get here can be useful, the gross profit method is not acceptable for determining year-end inventory totals or for audited financial documents. And finally, we come to our last ending inventory approach: the retail method.
As the name suggests, this one is commonly used by retailers and uses a proportional relation between retail price and costs in earlier periods. With all that groundwork out of the way, you can finally calculate the ending inventory with this formula:. To expand on the con of this method, the issue is that the retail method is only accurate if all pricing is the same and all pricing changes occur at the same rate.
Markdowns, sales, product damages, depreciation, and theft can all have a profound impact with this method. All of the methods outlined in this article are useful and can help you determine your ending inventory amounts. However, each has its own unique set of advantages and disadvantages as well. The good news is you are now armed with enough information about each approach to start determining which system will best serve your business. Want to learn more about inventory management?
Your email address will not be published. This site uses Akismet to reduce spam. Learn how your comment data is processed. Ready to learn more? What is Ending Inventory? What is the Formula to Calculate Ending Inventory? PROS Easier to calculate costs with a high volume of goods Saves time when determining how to set prices Makes manipulating accounting figures more difficult Provides a more accurate snapshot of how business is doing CONS If prices have gone up during an accounting period, you may sell items at a loss Calculations are more difficult when you have a wide range of products with slight variations.
Gross Profit Another way to determine your ending inventory amount is by using a gross profit calculation. To calculate ending inventory you start by adding the beginning inventory and net purchases, then subtracting the cost of goods sold COGS. So the ending inventory formula is:. Knowing your ending inventory value helps you make informed decisions for the financial year ahead. Imagine you are a stock manager for Jammin It Out, a company that makes jam. As the end of financial year approaches, you need to create an inventory report to understand the value of the assets you hold.
You access balance sheets to calculate ending inventory:. In short, yes. Integrating your accounting software and inventory management software means that your apps will do the heavy lifting for you. All you have to do is maintain accurate stock information so that any information that flows through to your accounting software is correct. Using the right software can help you accurately determine the value of your ending inventory much more quickly and with less stress.
It is important to calculate ending inventory because product businesses need to maintain accurate balance sheets and create consistent reports. Overstating or understating ending inventory will impact COGS, gross margin and net income on the balance sheet. An incorrect inventory valuation causes two income statements to be wrong because the ending inventory carries over to the next financial year as the beginning inventory.
Recording an accurate measure of inventory value will prevent discrepancies in future reports. To accurately calculate ending inventory, you should also conduct a physical count of the remaining inventory stock on hand.
A physical inventory stock count allows you to uncover any discrepancies between the actual stock and what you have in your inventory management system. This process requires the accuracy of all data inputs at many levels of the business — from physical inventory stock counts to accurate sales and purchase data.
Regardless of who actually calculates this figure, all managers and business owners should also have a basic understanding of these figures to help assess what future actions your business should take. Beginning inventory and WIP inventory play an important role in your ending inventory. The beginning inventory for the current financial year is the ending inventory amount for the previous financial year. To calculate beginning inventory you start by adding COGS and ending inventory, then subtracting net purchases.
So, the beginning inventory formula is:. The beginning inventory figure represents all the inventory stock a business can put towards generating revenue. Businesses can use the beginning inventory formula to understand the value of their inventory at the start of a new financial year. You can track changes to any beginning inventory by comparing this with the previous period.
Any changes usually signal a shift in the business, for example, decreasing beginning inventory could be a result of an increase in sales during the period, or it could be down to a supply chain or inventory management process issue. Increased beginning inventory could also be due to a business increasing stock before a busy holiday season — or it could signal a downward trend in sales.
While the number of inventory units remains the same at the end of an accounting period, the value of ending inventory is affected by the inventory valuation method selected. FIFO first in, first out method is used during a period of rising prices or inflationary pressures as it generates a higher ending inventory valuation than LIFO last in, first out.
The most obvious way to calculate closing inventory is by doing a physical count at the end of each month and then to value the inventory using a valuation method such as LIFO, FIFO and Weighted Average Method. Hence an estimation method is used for estimating closing inventory. The retail inventory method is commonly used by retailers to calculate their ending inventory.
This method uses the proportion of the retail price to cost in prior periods. The calculation is:. This method only works if you consistently all products are marked up by the same percentage. This means that if there are a series of discounts for stock clearance after the main selling season, it can change the outcome of this calculation.
Partially completed inventory is known as work in process is inventory. This inventory requires additional processing before it can be classified as finished goods inventory.
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