Articles
Demand & Inventory Planning

How to Calculate Ending Inventory and Why It Matters

Demand & Inventory Planning
September 3, 2021
11 min read
Share:

This straightforward guide includes 5 formulas for calculating ending inventory with step-by-step examples. Decide which formula works best for your business and learn how calculating ending inventory can improve forecasting and inventory management.

What Is Ending Inventory?

Ending inventory is an inventory accounting term that represents the total value of inventory you have ready to sell (or finished goods). Most businesses calculate ending inventory at the end of an accounting period, including it as an asset on their balance sheet for calculating taxes and accurately estimating the value of their business. 

Although the most accurate methods of calculating ending inventory include a physical inventory count, the purpose of calculating it is to determine the value of the inventory on hand, not the number of units. This is especially important when determining the value of your business for obtaining financing or pitching to potential investors. There are a number of methods that can be used to calculate ending inventory, and each method will yield a different value, even if the amount of inventory stays the same.

Why Calculate Ending Inventory?

Calculating ending inventory not only helps with determining the value of your business but also cuts down on inventory shrinkage and helps with forecasting. Building a forecast based on the value of inventory rather than simply SKU velocity and total sales enables forecasting that keeps profitability in mind so you don’t run the risk of selling yourself out of business.

It also helps with proactive supply chain planning by connecting inventory forecasting and availability to a promotional schedule. This way you can align your marketing efforts with SKU availability to strike the right balance of keeping inventory carry costs low without missing out on potential sales.

How to Ensure Accurate Ending Inventory Calculations

Data integrity is vital to accurate ending inventory calculations, and having an accurate calculation at the end of each accounting period helps track actual vs expected inventory to cut down on inventory shrinkage and unexpected stockouts. The most important variable in calculating ending inventory is having an accurate inventory count. Hand-counting inventory is tedious, especially for fast-growing businesses.

Partnering with a tech-enabled 3PL can automate the process of monitoring inventory and make real-time inventory reporting available through an intuitive cloud-based WMS. A fulfillment partner should also have SLA’s that include regular inventory cycle counts with a 99% accuracy rate to ensure the best and most accurate data for calculating ending inventory.

Ending Inventory Formulas

At the most basic level, ending inventory is:

beginning inventory + net purchases – cost of goods sold (COGS)

Much like calculating WIP inventory, the first variable, beginning inventory, is found by carrying over the ending inventory from the previous accounting period. There are a few methods for calculating ending inventory that will result in different values. The physical number of units on hand will not change, but their estimated value will change based on the method used.

How to Find Ending Inventory Using FIFO

FIFO (First in First Out) is an inventory tracking protocol that assumes that the first units of inventory purchased or manufactured are the first to be sold. Using FIFO to calculate ending inventory means that the cost of purchasing the oldest inventory (or First in) will be allocated first to COGS, and the cost of the newest inventory will be allocated to ending inventory. This means that if the cost of purchasing or manufacturing your inventory increased since your oldest inventory was purchased, your COGS will be lower for the first items sold (First out).

For example, you begin an accounting period with 100 units of a certain SKU purchased (or manufactured) at $5 per unit. Then later in the accounting period you place a replenishment order for 100 more units at $7 per unit. The entire accounting period, you sell 125 units. To calculate your COGS, you’ll use the cost of the first 100 units you ordered (5 x 100 = $500) plus the 25 units sold from your replenishment order (7 x 25 = $175), so your total COGS for that accounting period will be $675.

Using the ending inventory formula with this COGS value would give you the following ending inventory:

$500 (beginning inventory) + $700 (net purchases) – $675 (COGS) = $525 (ending inventory)

How to Find Ending Inventory Using LIFO

LIFO (Last in First Out) is an inventory tracking protocol that assumes that the inventory purchased or manufactured most recently were sold first.  Using LIFO to calculate ending inventory means that older inventory is allocated to ending inventory, while newer inventory (Last in) is allocated first to COGS. This means that if the cost of purchasing or manufacturing your inventory increased since your oldest inventory was purchased, your COGS will be higher for the first items sold (First out).

Let’s assume again that you have 100 units of a single SKU purchased (or manufactured) at $5 per unit. Then later in the accounting period you place a replenishment order for 100 more units at $7 per unit. Then, throughout the entire accounting period, you sell 125 units. To calculate your COGS using the LIFO method, you would use the cost of last 100 units you ordered (7 x 100 = $700) plus the 25 units you sold from your original order (5 x 25 = $125), so your total COGS for the accounting period would be $825.

Using the ending inventory formula with this COGS value would give you the following ending inventory:

$500 (beginning inventory) + $700 (net purchases) – $875 (COGS) = $325 (ending inventory)

How to Find Ending Inventory Using WAC

WAC (weighted average cost) averages your COGS based on the cost of all inventory purchased during the accounting period divided by the total number of units on-hand. Using the WAC method to calculate ending inventory means that all units are given the same (weighted) value.

We’ll assume again that you have 100 units of a SKU purchased (or manufactured) at $5 per unit. You then place a replenishment order for 100 units at $7 per unit. Throughout the accounting period you sell a total of 125 units. Using the WAC method, you would add the total cost of both orders (500 + 700 = $1,200), then divide that by the total number of units (1200 / 200 = $6 per SKU) Your COGS would be calculated by multiplying your weighted average cost of $6 by the number of units you sold (6 x 125) for a total of $750.

Using the ending inventory formula with this COGS value would give you the following ending inventory:

$500 (beginning inventory) + $700 (net purchases) – $750 (COGS) = $450 (ending inventory)

Alternate Ending Inventory Formulas

In the three examples above, the same formula is used to calculate ending inventory, but the method of determining the cost of goods sold (COGS) variable was different, which led to a different ending inventory valuation, although the physical number of units on hand never changed. There are 2 other common ways to calculate ending inventory that are slightly more complex and use a different formula altogether: the gross profit method and the retail method.

How to Find Ending Inventory Using the Gross Profit Method 

The gross profit method is useful for a quick estimation of ending inventory, but is not appropriate for end-of-year accounting because it doesn’t include a physical count of inventory. The formula includes a new variable, the cost of goods available for sale, which is calculated by adding the cost of beginning inventory with the cost of replenishment inventory. The gross profit ending inventory formula is:

Cost of goods available for sale – COGS = ending inventory

For the sake of simplicity, we’ll use the same company example as our previous formula. In this example your company had a beginning inventory of 100 units purchased at $5 each, then placed a replenishment order of 100 units at $7 each. This gives a total cost of goods available for sale of $1,200.

The next variable is a familiar one: cost of goods sold (COGS), but we’ll use gross profit margin to determine its value. Using our same example, we’ll assume that the SKU’s in question are sold for $10, yielding a gross profit margin of 40%. Again, we’ll assume you sold 125 units throughout the accounting period for a total of $1,250 in sales. You would then multiply your total sales by your gross profit margin ($1,250 x 40%) for $500 in COGS.

To find ending inventory, simply subtract your COGS from your cost of goods available for sale. ($1,200 – $500 = $700 ending inventory)

How to Find Ending Inventory Using Retail

The retail method is similar to the gross profit method in that it doesn’t require a physical count of inventory. If you have the variables available it can be a quick way to get an estimate of ending inventory, but it is not a very reliable method, especially if your prices change regularly. For most ecommerce and multichannel sellers, prices may change daily using tools like automatic repricers to help win the buy box and stay at the top of search algorithms. For those reasons, we won’t go into great depth about the retail method.

The basic formula for the retail method is cost of goods available for sale – cost of sales = ending inventory. You can determine the cost of goods available for sale using the same method as the gross margin method. To find the cost of sales, you must multiply your total sales by your cost to retail percentage.

How Ware2Go Can Help

Ware2Go’s cloud-based WMS, FulfillmentVu is the industry-leading fulfillment and supply chain platform. It enables real-time order updates and inventory tracking across multiple sales channels and multiple warehouse locations. Its open API and robust integrations ecosystem enables it to fit seamlessly into any tech stack to simplify inventory accounting and streamline supply chain management.

To learn more about how Ware2Go’s platform can simplify inventory management for your business, reach out to one of our supply chain experts.

Our Newsletter

Get our latest insights on how to make your supply chain your competitive advantage

1-2 insight per month
Thanks for subscribing!