At the end of an accounting period, it is of utmost importance that companies calculate how much stock is left over. This stock is known as closing inventory and its value lies in being able to better depict a company’s current assets and gross profits, and is a crucial aspect of inventory management and accounting. This article will be studying everything about closing inventory: how to calculate it, how it is used, as well as various examples.
What is Closing Inventory?
Closing or ending inventory is defined as the total value of inventory items that have remained unsold at the end of any given accounting period. Calculating one’s closing inventory holds many purposes, with one of the main purposes being its representation of the carrying costs of unsold goods. This encompasses expenses such as storage, insurance, and the tied-up capital invested in inventory. As previously mentioned, closing inventory reflects the value of goods remaining on the company’s books at the end of an accounting period, serving as a reminder of the financial commitment associated with inventory.
How Ending Inventory is Used
There are many areas of business operations in which ending inventory plays a vital role. One of the first examples of how ending inventory is used is financial reporting. Generating accurate financial statements means that all remaining inventory has been reflected and accounted for on the balance sheet. This provides stakeholders with insight into the company’s asset position, which can often play a large part in affecting financing from investors and creditors.
Secondly, ending inventory needs to be determined if the company wishes to calculate the cost of goods sold (COGS). By subtracting the value of ending inventory from the sum of the beginning inventory and purchases, businesses are able to accurately determine the COGS. This information is fundamental in calculating gross profit, which is a key indicator of a company’s profitability.
Inventory management is a clear factor of ending inventory, as closing inventory involves determining the amount of stock unsold at the end of an accounting period, and thus, how the stock needs to be stored and managed. Moreover, by comparing the value of ending inventory to sales revenue, businesses are able to analyse inventory turnover ratios. A high turnover ratio indicates efficient inventory management, whereas a low turnover ratio may suggest slow-moving or obsolete stock that ties up capital unnecessarily. Read this previous article on how to improve your inventory turnover ratio.
Additionally, closing inventory is essential for making informed decisions about production, purchasing, and pricing. By assessing the value and composition of the ending inventory, businesses are able to determine which products are in demand, and thus, which should be re-ordered or re-purchased. Furthermore, by understanding the COGS as well as the value of the ending inventory, businesses can calculate accurate product costs and set competitive prices that cover expenses and generate profits.
Closing Inventory Formula
After explaining the weighty importance of closing inventory, you might be wondering how it is calculated. Let us assess:
Ending inventory = beginning inventory + net purchases – COGS
Beginning inventory can be described as the value of inventory at the beginning of an accounting period, which is equal to the ending inventory value of the previous accounting period. The net purchases is the cost of any items that a company has purchased and has added into its inventory during the accounting period. And as explained before, COGS is the cost of manufacturing or purchasing the finished goods that were sold during the accounting period. Essentially – ending inventory is equal to the value of the beginning inventory added together with a company’s net purchases, with the subtraction of the cost of goods sold.
How to Calculate Ending Inventory
Take this example of calculating a company’s ending inventory to better understand the steps associated with the calculation, and how the formula is used in a real-life setting!
Step 1: Gathering Data
Gathering data means ensuring that all information used within the calculation is accurate and gathered from previous financial records, inventory management systems, or purchase invoices.
Beginning inventory: EURO 10 000
Purchases: EURO 15 000
COGS: EURO 12 000
Step 2: Add Beginning Inventory and Purchases
As the first half of the calculation dictates, add together the beginning inventory and net purchases amounts. This total represents the total cost of goods available for sale.
EURO 10 000 (Beginning inventory) + EURO 15 000 (Net purchases) = EURO 25 000 (Total cost of goods available for sale)
Step 3: Subtracts COGS from the Total Goods Available for Sale
Subtract the COGS from the total goods available for sale to yield the value of the ending inventory.
EURO 25 000 (Total goods available for sale) – EURO 12 000 (COGS) = EURO 13 000 (Ending Inventory)
Step 4: Verify Accuracy
Last, but certainly not least, it is important that values and calculations are checked and verified to ensure accuracy and mitigate any mistakes. Accurate data and precise calculations are essential for reliable financial reporting and informed decision-making.
Examples of Ending Inventory
There are different inventory valuation methods that can be used. Let us assess how FIFO and LIFO would be used in ending inventory calculations.
FIFO (First-In-First-Out)
This method follows the notion that the first goods ordered and arrived will also be the first goods sold. To calculate COGS using the FIFO method we must first determine the cost of our oldest inventory and multiply that cost by the number of units sold.
LIFO (Last-In-First-Out)
Differing from FIFO, LIFO assumes that the most recently purchased items are sold first. This method is often used when the cost of inventory is increasing or in the presence of high inflation. To calculate COGS using the LIFO method we must first determine the cost of our newest inventory and multiply this by the number of units sold.
Why is Ending Inventory Important?
Ending inventory provides valuable insights into a company’s financial position and is thus of utmost importance for financial analysis, decision-making, and effective inventory management. Ending inventory data influences strategic decisions regarding production, purchasing, pricing, and resource allocation, ensuring optimal inventory levels are kept to, and that profitability is maximized. Moreover, it enables businesses to anticipate customer demand based on what has been sold, thus allowing for the streamlining of supply chain management and inventory turnover. The use of Inventory optimization software can greatly simplify the calculation of ending inventory, providing real-time stock value. Request a demo now.
