Ending inventory is an essential metric system for any company that sells products. A clear understanding of the company's assets, profits, and tax obligations depends on an accurate assessment of ending inventory. In this article, we will discuss ending inventory management, why it is important to calculate it, its formula, and why it is crucial for accounting needs.
What Is Ending Inventory (or Closing Inventory)?
Ending inventory, also called closing inventory, is the cost of the goods a business has in stock and is ready to sell at the end of a specific accounting period. Companies can better understand their current assets and gross profit by knowing how much stock is left at the end of an accounting period.
They can also determine whether their inventory management systems are accurate and whether they need to change their ordering and production to meet demand better.
Why Is Ending Inventory Important?
Keeping track of ending inventory is important for accounting, taxation, and business management. The company's ending inventory may be one of its most valuable assets, so it's critical to ensure it is correctly tracked and valued.
The method of inventory valuation chosen affects the company's gross and net profit, and any resulting tax. Effective inventory management enables businesses to establish suitable pricing and sales strategies while ensuring they have enough products to satisfy customers.
How Is Ending Inventory Used?
Knowing the value of the ending inventory helps businesses understand their financial situation clearly. The cost of ending inventory formulas is calculated by subtracting the cost of inventory sold during each period and adding it to the company's COGS (cost of goods sold). It immediately affects the income statement's gross profit, which is determined by deducting COGS from net sales revenue. Therefore, ending inventory valuation impacts how much income tax the company must pay for the period.
How to Calculate Ending Inventory
The fundamental approach to calculating ending inventory is simple. You need to note down the beginning inventory at the outset of the current accounting period, followed by adding the cost of new purchases made and subtracting the COGS.
Ending Finished Goods Inventory Formula = beginning inventory + net purchases - the cost of goods sold
- Beginning inventory is the inventory value at the beginning of the period and is calculated as equivalent to the ending inventory value from the previous accounting period.
- Net purchases refer to the price of any goods or products a company has bought and added to its inventory throughout the accounting period.
- The cost of goods sold is the price of producing or buying the finished goods sold during the period.
Ending Inventory Methods
There are numerous ways to determine ending inventory, each with advantages and disadvantages of its own:
1. First In, First Out (FIFO)
The FIFO method for ending inventory is reliable because it suggests items are sold in the order they were ordered. As a result, it bases its calculation of COGS on the inventory that was bought first. A higher income tax charge for the current period may result from the higher profit.
2. Last In, First Out (LIFO)
Last in, first out (LIFO) refers to the recently purchased inventory being sold first. Because LIFO increases COGS when prices rise, the current period's gross profit and income tax bill are reduced. The lower ending inventory value is a side effect of the higher COGS.
3. Weighted Average Cost (WAC)
Using this method, a business merely averages all inventory costs to determine COGS and ending inventory. When a company sells numerous identical items, WAC is especially helpful. Calculating ending inventory is simpler because there is no need to keep track of the costs of individual inventory purchases in these situations.
4. Gross Profit
When it is impossible or inconvenient to determine the actual number of inventory items the company has, the gross profit method is used to estimate the ending inventory value. Using this method to calculate COGS and ending inventory, the company's expected gross profit margin for the current period serves as a starting point.
5. Retail Method
Retailers use the retail method to determine the market value of their products at a particular time. It uses the cost-to-retail ratio, calculated by dividing the total cost of available goods for sale by their retail price. The technique is helpful for retailers who apply a uniform markup percentage to every item they purchase.
Examples of Ending Inventory
Let’s try to understand the concept with an example. To prepare financial statements after the current period, the hypothetical company 123 Holdings must determine the ending inventory.
- The company had 100 inventory units at the beginning of the current quarter, and all were bought for 820 INR each.
- The business sold 200 units in the quarter.
- At the end of the period, the company had 100 inventory items instead of the three additional batches of inventory it had replaced them with.
The upcoming example shows how the company can calculate the cost of ending inventory value.
Example:
In order to calculate COGS for the 200 items sold in the quarter, the first step is to calculate the cost of goods sold. It is assumed that these were the first things bought using FIFO (first in, first out):
- As part of the beginning inventory, 100 items totaling INR 8200 were bought for INR 82 each.
- For a total of INR 48,000, 50 items were purchased for INR 960 each.
- A total of INR 61,500 was spent on 50 items for INR 1230 each.
- Because they were the last items to arrive and weren't sold, purchase number three is not included in the calculation.
The result is that COGS is INR 1,92,700 (82,000 + 48,000 + 61,500), and the ending inventory is INR 1,600 (INR 3,950 - INR 2,350).
Calculate Ending Inventory With Inventory Management Software
Many companies use inventory management software to automate the procedure because manually tracking ending inventory with spreadsheets is incredibly time-consuming and there can be errors. Systems for managing comprehensive inventory in the cloud can monitor inventory in real time throughout all locations.
Master Ending Inventory With TranZact
Ending inventory impacts the balance sheet and income statement of any business that sells physical goods. It's important to pick a valuation method that works for the business because the decision can impact the assets' stated value, profit, and tax liabilities. Therefore, TranZact helps businesses determine the right inventory management practices with its inventory management system.
Key Takeaways
- Ending inventory measures the worth of a company's products on hand for sale at the conclusion of a specific accounting period.
- The company's balance sheet, profit, and tax liabilities are all impacted by how ending inventory is determined.
- Many businesses employ the first in, first out (FIFO) or weighted average cost (WAC) approaches for precision and simplicity.
- When reliable inventory counts are impossible, ending inventory can be estimated using the gross profit and retail approaches.
- Software for inventory management helps automate inventory tracking and makes calculating ending inventory easier.
FAQs on Ending Inventory
1. What potential difficulties or dangers does ending inventory have?
Ending inventory have inaccurate valuation that results in inaccurate financial reporting. Also the risk of overstocking or understocking, and the effect of inflation or shifting market conditions on inventory value are a few common problems.
2. Can damaged or unsellable items be included in the ending inventory?
Usually, damaged or unsaleable items are left out of the ending inventory and may need to be separately recorded as write-offs or adjustments.
3. What techniques can be used to improve ending inventory management?
Implementing just-in-time (JIT) inventory systems, routinely performing demand forecasting and inventory analysis, and many other techniques are ways to optimize ending inventory management.
4. What should be listed in the closing inventory?
The cost of the goods sold during the period, any purchases made during the period, and the beginning inventory at the beginning of the period are all included in the ending inventory.
5. What do you mean by ending inventory for the current period?
The beginning inventory from that same period plus all purchases made during that period, less the total cost of goods sold for the period, equals the ending inventory for a current accounting period.
6. Is ending inventory considered an expense?
Ending stock is a resource, not an expense. The inventory cost is treated as an expense when it is sold, and the sum is added to the company's COGS for the period.
