Managing inventory is an important part of eCommerce. What’s selling? What’s not? Should you adjust purchasing? Gaining a clear picture of inventory allows you to make the best decisions for the coming business cycle.
Ending inventory is the inventory left over at the end of an accounting period. This reflects the market value of goods you have on hand. When you know the ending inventory, you can determine the cost of goods sold (COGS) as well as your ending inventory balance for your balance sheet. This way, you can get an accurate picture of your net income and make decisions based on accurate inventory counts.
In this article, we show you how to calculate ending inventory with the ending inventory formula. You’ll also learn three accounting methods that help you maximize your ending inventory.
These ending inventory tips are part of Easyship’s efforts to help businesses of all sizes succeed in eCommerce. We offer direct partnerships with a global network of trusted warehouses and third-party logistics providers (3PLs) with exact inventory management systems to empower your eCommerce goals.
Table of Contents
What is Ending Inventory?
Ending inventory is the sellable inventory that remains at the end of an accounting period. Calculating ending inventory is the process of matching your recorded inventory with your actual inventory.
For the purposes of accounting, it’s also the monetary value of those unsold goods. This helps you account for inventory variations due to discounts and returns, which may distort the figures of a basic inventory count.
Calculating ending inventory is important for a handful of reasons, including:
- Find the cost of goods sold (COGS): Finding COGS lets you find your gross profit, margins, and identify ways to improve inventory ordering
- Match recorded inventory to actual inventory: This lets you match your inventory balance sheet with your stock list, so you can identify inventory shrinkage due to loss, theft, spoilage, etc.
- Calculate net income: Helps you determine what you make on what you’re selling. A mismatch on inventory can suggest that you’re overpaying for inventory or you might want to adjust your pricing strategy
- Determine net income for tax purposes: A complete balance sheet claims all inventory as an asset for tax savings
Companies calculate ending inventory at the end of every accounting period. This is because ending inventory for this accounting period is the beginning inventory for the next accounting period. And so, calculating ending inventory keeps your ordering on track and your company on budget.
The Ending Inventory Formula
The ending inventory formula is:
Beginning Inventory + Net Purchases – Cost of Goods Sold (COGS) = Ending Inventory
- Beginning inventory: The ending inventory from last accounting period, or the total goods in inventory
- Net purchases: All items purchased and added to inventory in the same accounting period
- Cost of goods sold (COGS): All costs associated with purchasing or manufacturing goods in preparation for their sale
The most accurate way to calculate ending inventory is physically counting items on hand at the end of each period. However, this approach may only work for smaller companies.
Businesses with large inventory volumes as well as high volumes of sales often see their inventory counts change rapidly. This would make any previous physical inventory count inaccurate. Understating or overstating your ending inventory leads to overstated costs of goods sold. This will lead to an inaccurate picture of your net income, assets, and equity.
Since accuracy is key, many businesses opt to estimate ending inventory with one of two ending inventory formulas.
How to Estimate Ending Inventory
This section shows you two ways to calculate an ending inventory estimate. You’ll learn the ending inventory formulas, followed by examples of how it's done.
The Gross Profit Method
The first ending inventory formula is called the Gross Profit Method. It uses your gross margin percentage from the previous year as a benchmark for calculating ending inventory.
This method is only accurate if your historical gross margin matches your current gross margin. Any mismatch in gross margins will skew the inventory calculation. Here are the three steps:
- Calculate the cost of goods available for sale: Add the cost of beginning inventory to the cost of purchases during the same period
- Calculate the cost of goods sold: Multiply the gross profit percentage by sales in the period
- Calculate ending inventory: Subtract the estimated cost of goods sold from the cost of goods available for sale
An Example of The Gross Profit Method
Say your online store has a beginning inventory value of $175,000 in January. Your inventory purchases were $225,000 in January. Sales in January were $500,000. Your gross margin percentage has been 35% for the past 12 months.
What’s your ending inventory for January?
Step #1: Find the Cost of Goods Available for Sale
(Beginning inventory + Total purchases)
$175,000 + $225,000 = $400,000
Step #2: Estimate the Cost of Goods Sold
(1 - expected gross profit %) x Sales
(1-35%) x $500,000 = $325,000
Step #3: Find estimated Ending Inventory
(Cost of goods available for sale - Estimated cost of goods sold)
$400,000 - $325,000 = $75,000
The Retail Inventory Method
The Retail Inventory Method is a good alternative to the Gross Profit method for businesses with a shifting gross margin. This formula uses the retail-price-to-cost percentage from the previous year as its baseline, instead of the gross margin percentage.
The Retail Inventory formula only works for businesses that mark up their products by the same percentage in a period. If you offered promotions during a period such as stock clearance discounts, it can throw off these calculations.
Follow these steps to find ending inventory with The Retail Inventory Method:
- Find the Cost-to-Retail percentage: Divide the cost of retail goods by the initial cost of those goods
- Find the Cost of Goods Available for Sale: Add the cost of beginning inventory with cost of all inventory purchases
- Find the Cost of Sales during the period: Multiply sales revenue by the cost-to-retail percentage found in step one
- Calculate Ending Inventory: Subtract the cost of goods available for sale from the cost of sales in the accounting period
An Example of The Retail Inventory Method
Say you’re a retailer that sells luxury footwear. You buy shoes at $140 and sell them at $200 on average.
Beginning inventory for January was $1 Million. You made $1.8 Million in additional inventory purchases during the January period. Sales for the month were $2.4 Million.
What’s your ending inventory for January?
Step #1: Find the Cost-To-Retail percentage
Step #2: Find the Cost of Goods Available for Sale
(Cost of beginning inventory + Cost of purchases)
$1,000,000 + 1,800,000 = $2,800,000
Step # 3: Find the Cost of sales
(Sales x Cost-to-retail percentage)
$2,400,000 x 70% = $1,680,000
Step #4: Calculate Ending inventory
(Cost of goods available for sale - Cost of sales during the period)
$2,800,000 - $1,6800,000 = $1,120,000
3 Approaches to Calculate Ending Inventory
Your approach to inventory calculations can have a big impact on ending inventory, and therefore your bottom line.
Professional accountants recommend that you adjust your annual accounting practices to match your inventory type as well as market conditions. For example, fluctuations in inventory prices due to inflation can diminish the valuation of your ending inventory.
Here are three different ways to approach your calculations for ending inventory. It’s best to use only one method of accounting each year, as this will ensure accuracy for future reports.
First In, First Out (FIFO)
The First-In, First Out (FIFO) accounting method assumes that your company sells its older inventory before the newer inventory. This is a good option for businesses whose goods may expire, such as food items or CBD products.
With the FIFO method, your ending inventory value will reflect the current cost of your product as based on the most recently purchased item in your inventory. This means that if prices increase, the value of your ending inventory also increases. This safeguards your investment during times of inflation or price increases.
Say you bought 10 hoodies at $20 in January, then 10 of the same hoodies at $25 in February.
If you sell 10 of the 20 total hoodies, the FIFO accounting method means you would sell the 10 bought for $20 in January first, and record your cost of goods sold at $200. The remaining inventory of 10 hoodies, bought for $25, shows a higher value than it would if you’d sold the $20 hoodies.
Last In, First Out (LIFO)
The Last-In, First Out (LIFO) accounting method assumes that you sell newer inventory before older inventory. In other words, the cost of the last inventory item bought is the price of the last product sold. The LIFO method helps businesses keep inventory values up during times of decreasing prices.
Let’s revisit our example of the $20 and $25 hoodies.
With LIFO accounting you sell the $25 hoodies first instead of the $20 hoodies. Your cost of goods sold would be $200, as opposed to $250 under the FIFO method. If prices are falling, your business performance will be improved by showing a lower-value inventory.
Weighted Average Method (WAC)
The weighted average method (WAC) is best for businesses whose products are identical, or are limited to just a few SKUs.
With WAC, you divide the total amount spent on on-hand inventory by the total number of on-hand items. The result is an average of the cost of purchased goods in your inventory over the accounting period.
Let’s say our beginning inventory are those 10 hoodies bought for $20, and 10 hoodies bought at $25. With WAC, our average inventory value is $22.50 and our ending inventory value is $450, assuming no purchases were made.
Calculating Ending Inventory
Calculating ending inventory is a vital step in business accounting. The methods we’ve outlined today can give you a reasonably accurate estimate of ending inventory, helping you determine your cost of goods sold and inventory balance for your balance sheet. However, these formulas are by not means exact.
Inventory management systems, though expensive, can give you exact inventory counts in real-time. For most businesses, the most affordable way to access these systems is to partner with third-party logistics providers (3PLs).
A quality warehouse partner will offer powerful inventory management software that integrates with your online store, giving you visibility of inventory, plus savings on last mile deliveries, and more. Easyship can help you find these trustworthy inventory partners here.
You can also create a free Easyship account to access the best inventory partners for your business.
Ending Inventory FAQ
How do you find ending inventory without the cost of goods sold?
Ending inventory = cost of goods available for sale less the cost of goods sold. There's no way around it, you have to find the cost of goods sold!
How to calculate ending inventory using FIFO
Add the cost of your most recent inventory purchases to the cost of goods sold before your earlier purchases, then add that figure to your ending inventory.
What affects ending inventory?
Relying on historical profit margin, which may not be the same as the margin in the current period, and running discounted sales such as clearance sales may affect the ending inventory value you get with each of the ending inventory formulas.
What happens if ending inventory is understated?
Understating ending inventory leads to overstated costs of goods sold. This will lead to an understatement of the net income, assets, and equity.