By Indeed Editorial Team
Updated February 22, 2021 | Published April 17, 2020
Updated February 22, 2021
Published April 17, 2020
Ending inventory is an important formula for any business that sells goods. This formula provides companies with important insight as to the total value of products still for sale at the end of an accounting period. Learning how much ending inventory is can help a company form better marketing and sales plans to sell more products in the future. In this article, we discuss what ending inventory is, the most common methods used to calculate this value and real-life examples of how to determine a company's ending inventory.
What is ending inventory?
Ending inventory is a term used to describe the monetary value of a product still up for sale at the end of an accounting period. This number is required to determine the cost of goods sold (COGS) and the ending inventory balance. A company's ending inventory should be included on its balance sheet and is especially important when reporting financial information to seek financing.
Smaller companies are sometimes able to calculate their ending inventory by simply counting the product leftover at the end of an accounting period. However, most companies use a formula to determine the total value of the product left over.
Related: What is the Cost of Goods Manufactured? Definition and Formula to Calculate
What is the formula to calculate ending inventory?
Here is the basic formula you can use to calculate a company's ending inventory:
Beginning inventory + net purchases - COGS = ending inventory
In this formula, your beginning inventory is the dollar amount of product the company has at the onset of the accounting period. The net purchases portion of this formula is the cost of any new product or inventory items bought during the accounting period. The cost of goods sold is the amount of money it costs to produce goods that are part of the company's inventory.
Related: How to Calculate Net Cash Flow
Calculating ending inventory
The following are the most common methods used to determine ending inventory:
First-in, first-out (FIFO) method
This method of calculating ending inventory is based on the assumption that the oldest items bought for the production of goods were sold first. Using this method, you assume that the first item bought is the cost of the first product sold. The ending inventory value derived from the FIFO method shows the current cost of the product based on the most recent item purchased.
This method of calculating ending inventory is formed from the belief that companies sell their oldest items first to keep the newest items in stock. It's important to note that during inflationary periods, the FIFO method will result in a higher ending inventory amount.
Last-in, first-out (LIFO) method
The last-in, first-out method is when a company determines its ending inventory by looking at the cost of the last item purchased. This method assumes that the price of the last product bought is also the cost of the first item sold and that the most recent items bought were the first sold. The LIFO method takes into account the most recent items bought first in terms of the cost of goods sold and allocates older items bought in the ending inventory.
You should note that during inflationary times, using the LIFO method can result in lower net income values and a decreased ending inventory value.
Related: Net Working Capital Formula: Here's What You Need to Know
Weighted-average cost (WAC) method
The weighted-average cost method gives a value to the ending inventory and COGS derived from the total cost of products produced or bought in an accounting period divided by the total number of products manufactured or bought. Unlike the first-in, first-out method and last-in, first-out method, the weighted-average cost method assigns the same value to each item bought. You can use this method to balance the LIFO and FIFO methods because it provides an average of all costs.
Ending inventory calculation examples
The following are examples of how to calculate ending inventory using the FIFO, LIFO and WAC methods:
Harod's Company has a beginning inventory of 1,000 units of product and purchases another 1,000 units at $5 each during the first month of an accounting period. In the next month, the company purchases another 1,000 units at $10 each. This means that a total of 2,000 units were purchased in the accounting period for a total of $15,000. At the ending of the period, the company has 500 units left, which means it sold 1,500 items during that period.
According to the FIFO method, the first units are sold first, and the calculation uses the newest units. So, the ending inventory would be 1,500 x 10 = 15,000, since $10 was the cost of the newest units purchased. The ending inventory for Harod's company would be $15,000.
During an accounting period, Invest Media purchases 2,000 units at $10 in the first month and 1,000 units the next month at $20. The first set of units totaled $20,000 and the second set of units also totaled $20,000. This means the company has a total of 3,000 new units in this accounting period and has spent $40,000 on the acquisition of these items. At the end of the accounting period, Invest Media has 750 units left, which means the company sold 2,250 units during that period.
According to the LIFO method, the last units purchased are sold first, so the value used for the ending inventory formula is based on the cost of the oldest units. This means that the ending inventory for this period for Invest Media would be 2,250 x 10 = $22,500.
Bayshore Company purchases 1,000 units at $10 each in the first month of a new accounting period. The next month, it purchases another 1,000 units at $15 each. The first set of units purchased cost $10,000 (1,000 x 10) and the second set of units purchased cost a total of $15,000 (1,000 x 15) for a total of 2,000 units and $25,000 spent on new inventory. At the end of the accounting period, the company has 500 units left, which means it sold 1,500 units in that period.
The weighted-average cost method takes the weighted average of all units in the company's inventory. So, (1,000 x 10) + (1,000 x 15) / 2,000 units = $12.50. This means that the ending inventory for Bayshore Company is 500 x 12.50 = $6,250.