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Calculate Ending Inventory For Online Businesses (The Right Way)

Calculate Ending Inventory For Online Businesses (The Right Way)

When you’re starting a business, there are tons of details that can keep you up at night.

One of the most common is the ending inventory and this article will show you just how simple it is.

There are a few steps to calculate your ending inventory and we’ll go through each one.

But before we get started, let’s make sure you understand what inventory is.

Inventory is simply everything that your business owns or has on order for resale.

If you sell products, then your inventory would be the products that are ready to go.

But what is exactly the ending inventory and how to calculate it?

What is the ending inventory

The ending inventory is the amount of products or materials that are left in stock at the end of an accounting period.

In order to calculate it, you need to know the beginning inventory and what was sold during that period.

Let’s take a look at an example:

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You started the year with 100 widgets in stock.

During the year, you sell 60 widgets.

At the end of the year, what is your ending inventory?

The answer would be 40 units as those are all that was left in stock at the end of the period.

The ending inventory figure is crucial when businesses seek financing and should be included on your balance sheet.

Smaller firms may manually count their stock by hand.

Larger businesses, on the other hand, generally use one of a number of different algorithms to determine the value of their remaining inventory (Which we’ll discuss later).

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How to calculate the ending inventory

Now that we have a solid definition for ending inventory, let’s discuss the formula you’ll use to compute your amounts at the end of each accounting period.

To calculate the ending inventory, you first need to start with your beginning inventory.

Beginning inventory + net purchases – COGS = ending inventory

Businesses frequently cite a lack of resources as the reason for their subpar inventory management.

While inventory management might be complicated, the math behind most of these numbers is straightforward.

It gets even easier with inventory management software.

However, you must know how to approach your opponent. So without further ado, let’s look at this formula in detail so you can get a better grasp on each component involved.

In the first portion of the equation, beginning inventory is the dollar value of your company’s goods on hand at the start of each accounting period.

Net purchases refers to all of the new items or inventory added to the equation during the accounting period.

The cost of goods sold is the sum you spend to create the items and products that are part of your inventory.

Let’s look at the most frequent methods for calculating ending inventory.

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Why Calculating ending inventory is important for your online business?

The distinction between selling and not selling is critical, so you’ll always want to know how much you’re selling Vs how much you’re not.

Ecommerce inventory may be referred to as simply another expense until it’s sold.

In eCommerce, calculating ending inventory is a best practice in both accounting and operational terms.

Here’s why:

Actual inventory is recorded in the database

You want to double-check that the figures on your inventory balance sheet correspond to what’s currently in your warehouse.

Knowing how much ending inventory you have establishes the accuracy of the inventory you’ve recorded, as well as whether or not it accurately reflects the actual physical inventory you have on hand.

If your inventory levels are insufficient, this might be due to

Calculates the net income after taxes

You also want to know how much money you’re making on what you’re selling, as well as how much revenue your business is generating.

Once you’ve calculated ending inventory, you’ll have a clear picture of whether or not your real inventory matches the recorded number.

If the figures don’t match, it may indicate that you’re paying too much for your goods, or that you’ve made a mistake in recording your purchases.

Maintains accuracy

How are inventory quantities determined?

The beginning inventory of a particular accounting period is derived from the previous period’s ending inventory.

Beginning balance is calculated by subtracting the final reporting period’s ending balance from the preceding reporting period’s beginning balance.

As a result, it is critical to get the correct end inventory figure.

There are a variety of techniques to value your ending inventory.

The approach you choose will influence everything from budgeting to inventory reorder quantity, as well as financial success.

End of period accounting methods have an impact on financial outcomes, so pick a method that’s appropriate for your company and stick with it.

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Ending Inventory techniques

FIFO (First in First out)

FIFO inventory costing method

The FIFO method of valuation is one of the most popular and easy to use methods.

When we apply this idea to inventory accounting, we assume that the first product bought was also the first product sold, and vice versa.

However, the initial product bought may not be the same as the first product sold.

The main advantages

  • It minimizes inventories and helps improve working capital turnover ratios, which in turn improves liquidity ratios of your business.
  • this inventory costing method is simple to apply, and it dries quickly.
  • the balance sheet amount for inventory is likely to approximate the current market value.

The main disadvantages

  • It’s not always the most accurate in reflecting the cost basis of an item.
  • Results in taxable gains when prices are rising, and taxable losses when they are falling.
  • Ignores economic realities that may lead to distorted financial statements.

Inventory is assigned costs as items are prepared for sale. This may occur through the purchase of the inventory or production costs, through the purchase of materials, and utilization of labor.

These inventory costs are based on the order in which the product was used, and for FIFO, it is based on what arrived first.

To understand the FIFO method better, we’ll look at an example.

Example

A company purchased 100 products for $10, followed by 100 products for $15.

You would record the cost of the first 100 items sold for $10 each. The new cost of an item after 100 units have been sold is always set to $15, regardless of whether additional inventory purchases are made.

FIFO is good for businesses with a smaller customer base, and those with the desire to remain agile.

It’s also preferred by businesses that seeks lower taxes and want to minimize their inventory holdings.

Tip: if you are planning to switch from your current inventory costing method to FIFO, do not make the switch all at once, This is because some of your previous purchases may be still in stock.

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LIFO (Last in First Out)

LIFO inventory costing method

The LIFO is the inverse of the FIFO.

Under this concept, you value your inventory by assuming that the last item bought was also the first one sold.

However, it is not necessary to do so at all times.

This inventory costing method may show a lower cost of your inventory, but it is not always true.

The main advantage

  • The profit on the sale of goods is reduced. This lowers the net income and results in a smaller tax obligation.
  • Any costs on purchases that are less than sales prices will also be relatively low.

The main disadvantage

  • Overvalues the cost of the first products bought, which results in an overstatement of taxable income.
  • Results in lower net income on your financial statements.
  • Will not always provide you accurate costs for items on hand at the end of period.

LIFO is not used as a valuation method for inventory. It’s mostly used as an accounting tool to help companies defer tax income into future periods.

Example

The same company that purchased 100 products for $10, followed by 100 products for $15.

The cost of the first 100 items sold is $15 each. After 100 units have been sold, the cost of an item is reset to $10.

LIFO is beneficial to businesses when price ricing, since they can match their revenue with the most recent expenses.

Tip: If you are planning to switch from your current inventory costing method to LIFO, do not make the switch all at once. This is because some of your previous purchases may be still in stock, and this will cause a significant fluctuation in your financial statements.

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Average Costing Method

Average Costing inventory costing method

Average costing method shows the average cost of all items in stock.

When your business decides to sell an item, the average cost of all items in stock will be used to record the sale.

This inventory costing method is beneficial to businesses for a variety of reasons. The weighted average of all the inventory that the business acquired throughout a period of time is used to assign value to COGS.

As long as the length stays consistent, it may be a month, quarter, or yearly period.

The main advantages

  • It provides a reasonable approximation of the value of inventory on hand.
  • It’s simple to utilize, and a basic formula makes calculating the average cost very straightforward. It may be calculated even if you don’t use an inventory management system.
  • With average costing, you’ll get more accurate and realistic data when comparing periods.
  • Due to its simplicity, the average costing technique is also the most cost-effective method since it requires little input.

The main disadvantages

  • This inventory costing method is works only with identical items – You can’t utilize average cost of inventory in industries with non-identical goods, such as the electronics industry. The term “computer” refers to a wide range of equipment that includes different characteristics, such as color, size, model, and so on.
  • Reporting Issues – If the cost of a stocked product fluctuates, it can cause reported sales profit to differ. Your pricing may not be able to recoup the expenses of things that are more expensive, resulting in revenue loss. You might even find yourself eliminating the product and never recovering your losses.
  • Aggregated costs – The average cost method calculates and distributes all costs as a single transaction before dispersing them across all items.

Example

The total cost of producing 40 haircuts at “The Clip Joint” is $320.

So to determine the average price of a haircut, divide the total cost by 40. $320/40= $8 per haircut.

Tip: Average costing is most effective when the costs of individual products stay relatively consistent over time, such as through use of production or purchasing contracts.

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Specific Identification Costing Method

This method assigns an individual cost to specific goods. When a product is sold, the cost of that product (specifically identified) will be removed from the balance sheet.

Specific identification becomes beneficial when you are trying to price your goods correctly. It’s the only cost allocation method that uses costs specifically attributed to an item or product.

It’s beneficial and practical, when a firm is able to identify, label, and track each item or unit in its inventory.

The main advantages

  • You’ll know the direct costs and expenses of items that you’re selling.
  • It’s easy to track and report because it assigns an individual cost for each item.

The main disadvantages

  • Complexity – It may require you to keep a vast amount of information on hand. You’ll need to identify different products as well as their components, such as material and labor.
  • Costly – It requires a high level of effort, time and money. If you plan to take a cost-effective approach to implement this method, it’ll require a lot of preparation and work from your team. Depending on the number of items that need specific identification, this will be much more costly than other methods.

Example

In August 2019, the firm sold 1,100 units. Of the total sales made, 400 units were sold out of purchases made on 01-Aug-2019; 200 units were sold out of purchases made on 08-Aug-19; 200 units were sold out of purchases made on 22-Aug-19; and the remaining 300 units were sold on 31-Aug-19.

Specific Identification Costing Method Example

Then the closing stock calculation would be as follows:

Specific Identification Costing Method Example to calculate the closing stock

The value of the closing stock on August 31, 2019, is $ 2,420.

Calculation of the cost of goods sold:

Specific Identification Costing Method to calculate COGS

The cost of goods sold for August, 2019, is $ 1,315.

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FAQ

What is the formula for calculating beginning and ending inventory?

The fourmala to calculate the ending inventory is: Beginning inventory + net purchases – COGS = ending inventory.

The fourmala tocalculate the beginning inventory is: Cost of Goods Sold + Ending Inventory) – Inventory Purchases during the period = Beginning Inventory.

How do you find ending inventory using average cost method?

Ending Inventory is calculated by multiplying the average cost per unit by the total quantity available at the end of the reporting period.

How do you find ending inventory using LIFO?

To calculate LIFO, take the cost of your most recent inventory and multiply it by the quantity sold.

How do you find ending inventory using FIFO?

To calculate FIFO, take the cost of your oldest inventory and multiply it by the quantity sold.

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