How to Use the Ending Inventory Formula (With Examples)
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Ending inventory is an important formula for any business that sells goods. This formula provides companies with important insight as to the total value of products still for sale at the end of an accounting period. Learning how much ending inventory is can help a company form better marketing and sales plans to sell more products in the future. In this article, we explain what the ending inventory formula is, tell you why using it's important, discuss the most common methods used to calculate this value, and offer real-life examples of how to determine a company's ending inventory.
What is an ending inventory formula?
The ending inventory formula is used to calculate the monetary value of a product that's still for sale at the end of an accounting period. This number is required to determine the cost of goods sold (COGS) and the ending inventory balance. Including a company's ending inventory on its balance sheet is especially important when reporting financial information to seek financing. Smaller companies are sometimes able to calculate their ending inventory by simply counting the product leftover at the end of an accounting period. But most companies use a formula to determine the total value of the product left over.
What is the formula for calculating ending inventory?
Here's the basic formula you can use to calculate a company's ending inventory:
Ending inventory = Beginning inventory + Net purchases - Cost of goods sold
In this formula, your beginning inventory is the dollar amount of product the company has at the onset of the accounting period. The net purchases portion of this formula is the cost of any new product or inventory items bought during the accounting period. The cost of goods sold is the amount of money it costs to produce goods that are part of the company's inventory.
Why is knowing your ending inventory important?
If you're deciding whether to calculate a company's ending inventory, knowing the benefits of doing so can help. Here are the advantages of knowing a company's ending inventory:
Compare your recorded inventory with your actual inventory
You may have a system that automatically records your inventory, but it may not accurately reflect your physical inventory. Calculating your ending inventory can verify that your recorded inventory is the same as your physical one. If it's lower than you thought, it may be a sign of shrinkage. This can occur because of issues like theft or accounting errors. Identifying this issue can help you solve it so your inventory records are accurate in the future.
Calculate your net income
Calculating your ending inventory can also help you accurately determine your net income. This is the company's earnings minus its expenses, taxes, interests, and cost of goods sold. Without calculating your ending inventory, your income estimate may reflect a price that's too high as you still have unsold product.
Create accurate reports
Your ending inventory can affect your future reports as well, not just the reports for the quarter or period you purchased the products. If you have inventory left at the end of the period, it may carry over to the next period or you may subtract it as a loss. Either way, knowing your ending inventory can help you consistently create accurate reports.
Different methods for calculating ending inventory
Here are three common methods for determining a company's ending inventory:
First-in, first-out (FIFO) method
This method of calculating ending inventory is based on the assumption that companies sell their oldest items bought for the production of goods first to keep the newest items in stock. Using this method, you assume that the first item bought is the cost of the first product sold. The ending inventory value derived from the FIFO method shows the current cost of the product based on the most recent item purchased. It's important to note that during inflationary periods, the FIFO method can result in a higher ending inventory amount.
Last-in, first-out (LIFO) method
The last-in, first-out method is when a company determines its ending inventory by looking at the cost of the last item purchased. This assumes that the price of the last product bought is also the cost of the first item sold and that the most recent items bought were the first sold. The LIFO method considers the most recent items bought first in terms of the cost of goods sold and allocates older items bought in the ending inventory. During inflationary times, using the LIFO method can result in lower net income values and a decreased ending inventory value.
Weighted-average cost (WAC) method
The weighted-average cost method gives a value to the ending inventory and COGS derived from the total cost of products produced or bought in an accounting period and then divides it by the total number of products manufactured or bought. Unlike the first-in, first-out method and last-in, first-out method, the weighted-average cost method assigns the same value to each item bought. You can use this method to balance the LIFO and FIFO methods because it provides an average of all costs.
Ending inventory calculation examples
Here are three examples of how to calculate ending inventory using each method:
Consider this example of a cafe calculating its ending inventory of mugs using the first-in, first-out method:
Coco Cafe purchased 100 mugs at $12 each during the first month of an accounting period, totalling $1,200. In the next month, the company purchased another 100 mugs, but for $10 each, totalling $1,000. In the final month of the period, the company purchased 75 mugs for $12, totalling $900. This means Coco Cafe purchased 275 mugs for a total of $3,100 during the accounting period. At the end of the period, the company only had 25 mugs left, so they sold 250.
The first-in, first-out method states that the company starts by selling the first units it purchased. This means the calculation for ending inventory is based on the last price of the mugs, which was $12. The final formula may be 25 x 12 = 300, so the company's ending inventory for this period is $300.
Here's an example of a clothing company calculating its ending inventory using the last-in, first out method:
During the first month of the quarter, Oishii Clothing purchased 5,000 t-shirts for $8 each, spending $40,000. In the second month, the company purchased another 5,000 t-shirts, but the price increased to $10 each, totalling $50,000. In the final month of the quarter, Oishii Clothing only purchased 3,000 t-shirts as the price increased again to $11, totalling $33,000. This means during this quarter, Oishii Clothing purchased a total of 13,000 t-shirts for $123,000. The company sold 11,500 t-shirts during this quarter, so they have 1,500 left by the end.
According to the last-in, first-out method, the last units that the company purchased were sold first, so the calculation is based on the cost of the original t-shirts, which were $8. This means that Oishii Clothing's ending inventory for the first quarter of the year is 1,500 x 8 = $12,000.
Here's an example of an ice cream parlour calculating its ending inventory of ice cream cones:
Blackcreek Creamery purchased 5,000 ice cream cone wrappers for $0.10 in July, the first month of the company's third quarter, for a total of $500. In August, the company purchased another 5,000 ice cream cone wrappers for $0.12, totalling $600. In September, the company purchased another 5,000 ice cream cone wrappers for $0.10, totalling $500. This means the company purchased 15,000 ice cream wrappers for $1,600 by the end of the quarter. It sold 14,500 ice cream cone wrappers, so it has 500 left.
The weighted-average cost method considers the weighted average of the cost of all units in the company's inventory. To calculate this average, the company can divide the final 500 ice cream wrappers by three to represent each month's purchases. Then, multiply the remainer by the cost of the ice cream wrappers. This is what the formula may look like, (166 x 0.10) + (166 x 0.12) + (166 x 0.10) / 15,000 = 0.003. This means Blackcreek Creamery's ending inventory is 500 x 0.003 = $15.
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