At the end of each financial year, companies need to calculate the result of their work for the whole year to establish whether they have made a profit or lost money.
One of the points within that exercise is the ending inventory, which is nothing more than the stock that a store has at the end of the year of work.
It is fundamental for determining a company’s economic results and efficiently managing the resources available in the following year.
The ending inventory includes all products, from raw materials (for manufacturers), to all finished goods available for sale.
Why is the ending inventory important in ecommerce?
From an ecommerce perspective, the ending inventory takes on a very important role within the sales chain.
We know that in a normal or traditional business, a customer enters a store and chooses the desired product from what they can see is available at that moment.
In ecommerce, the situation is a little different, since the customer is paying for something that they will not receive immediately and will have to wait a few days until it arrives.
For that reason, it is important to be extremely precise with the current stock that the store has in the warehouse in order to avoid cancellations or refund requests that can generate unnecessary friction and an unsatisfactory shopping experience for the user.
Comprehensive Guide to Calculating Ending Inventory
Above we talked about the importance of the ending inventory within the financial structure of an ecommerce business.
Here we are going to explain the basic formula for calculating the ending inventory and how to apply it within your business.
The basic formula for calculating ending inventory:
Ending Inventory = Beginning Inventory + Net Purchases – Cost of Goods Sold (COGS)
How to apply the ending inventory formula in your ecommerce business?
Suppose your store starts the year with €45,000 of initial inventory.
During the year, it purchases €29,500 worth of products and sells €54,000.
In this specific case, the calculation would be as follows:
Ending Inventory = €45,000 (Beginning Inventory) + €29,500 (Purchases) – €54,000 (Cost of Goods Sold) = €20,500.
The store’s ending inventory would be €20,500 and this value would be recorded as an asset on the balance sheet.
Consolidated Inventory Valuation Methods
We have already explained a basic calculation for the ending inventory of an ecommerce business.
However, there are various additional methods to calculate the ending inventory that can be adapted to the different dynamics and needs of a business.
Let’s review each of them:
| FIFO | LIFO | Weighted Average Cost Method |
|---|---|---|
| The FIFO method stands for first in, first out. It means that the first products to leave the warehouse should be those that have entered first. It is a method widely used in ecommerce with consumable or perishable products. You can also use it for textile products that may go out of fashion or even technological elements. | The LIFO method means last in, first out. In this case, it means that the last products to enter are the first to leave. In other words, the new merchandise takes priority over the others. This method is ideal for non-perishable products. An example of such products might be a store that sells construction elements such as sand or bricks. | The weighted average cost method calculates the average cost of all inventory products available for sale during a given period, which is then used to determine the cost of goods sold (COGS) and the value of ending inventory. |
How to Calculate Ending Inventory Without Cost of Goods Sold (COGS)
Although the goal should always be to stay up to date with your warehouse stock and accounting records, it is possible that, due to the very dynamics of an ecommerce business, there is a delay in this regard.
That is why sometimes it can be complicated to calculate the ending inventory without having the Cost of Goods Sold (COGS) at hand.
For this, there are two alternative methods that you can use to overcome this problem and estimate this value that is key to the correct management of the final inventory calculation.
Gross margin method
The gross margin method is useful when the gross margin percentage of your sales is known and the margin remains constant during the period, allowing for a COGS estimate that can then be used within the formula we showed at the beginning of the article for the ending inventory calculation.
Formula: Sales x (1 – Gross Margin Percentage)
Example:
Suppose a store has sales of €100,000 and a gross margin of 40%.
Estimated COGS = €100,000 x (1 – 0.40) = €100,000 x 0.60 = €60,000.
In this case the COGS we would use in the ending inventory formula would be €60,000.
Retail inventory method
This method is based on calculating the relationship between the cost and the selling price of a product and then using that estimate in the ending inventory formula.
It is useful for converting the sales value at the selling price to an inventory value at cost.
Example:
If ending inventory is €30,000 at cost, net purchases are €70,000 and sales at cost are €120,000 with a cost percentage of 70%, the formula for calculating ending inventory would be:
Ending Inventory = (€30,000 + €70,000) x 0.70 = €100,000 x 0.70 = €70,000.
This method is widely used within the retail industry to estimate your ending inventory especially when it is not possible to keep detailed control over costs.
This way you can effectively calculate your ending inventory without relying strictly on COGS and without putting your financial structure at risk.
Determining Cost of Ending Inventory
At the beginning of the article we stated that the cost of the final inventory is limited to goods like raw materials and the stock of finished products to sell in the warehouse.
Now, we can dive even deeper into this concept since from an ecommerce point of view there are other associated costs that also influence the calculation such as the cost of storage, handling and shipping.
In addition, product returns, damaged items and even some type of promotional discount can also influence the final inventory value.
As an example, let’s perform a final inventory calculation taking into account all these new factors appearing with an ecommerce business that have no influence in the offline world.
In this case the formula would be:
Ending Inventory = Beginning Inventory + Net Purchases + Storage Cost + Shipping and Handling Cost – Discount – Returns – Damage
With this in mind, let’s imagine and exemplify some possible scenarios
Example 1: Seasonal goods
Let’s imagine that we are in Q4 and our ecommerce store sells Christmas products. It is very likely that at the end of the period many of these products will still be in stock and we will have to employ promotions and discounts to sell them.
In this case, the ending inventory would be adjusted by subtracting the discounts applied to those products.
In other words, if the initial inventory of Christmas products was €50,000 and discounts of 30% were applied, the ending inventory would be reduced to €35,000.
Example 2: Consumable products
In the case of a consumable products store, this scenario becomes relevant since the products that reach their expiration date must be discounted and completely removed from the inventory.
For example, if, from an initial inventory of €10,000, during the year we are forced to dispose of products worth €2,000, we would have to adjust the endinginventory to €8,000.
Example 3: Damaged products
This is another very common example within the online world and includes products that, due to problems during transit to the customer’s delivery address, suffer blows or damage that inevitably results in the product being returned, making it impossible to sell.
Assuming that this ecommerce business has €30,000 of initial inventory and receives €5,000 back in returns due to damage, the value of the ending inventory would be reduced to €25,000.
How to Calculate Cost of Goods Sold Without Ending Inventory Data
One way to calculate the cost of goods sold without having the data on the ending inventory is through the inverse calculation.
For this we can use the gross margin of sales and with this information we can estimate the COGS by subtracting the gross margin percentage of sales, which gives us the percentage of cost of goods sold.
The formula is as follows:
COGS = Sales x (1 – Gross Margin Percentage)
If we wanted to quickly exemplify this formula, we could assume a scenario in which a company has had sales of €200,000 and a gross margin of 40%.
Applying the formula, the result would be as follows:
COGS = €200,000 x (1 – 0.40)
COGS = €200,000 x 0.60 = €120,000.
In this case, the COGS would be €120,000.
Inventory turnover ratios
Just as we talked earlier about methods such as gross margin or retail inventory, it is possible to use inventory turnover ratios to estimate ending inventory.
The inventory turnover ratio is a metric that allows you to measure how many times inventory is sold and replenished during a given period.
This is another very useful method to apply when inventory records are inaccurate or incomplete.
The formula is as follows:
Inventory Turnover = COGS / Average Inventory
The average inventory is calculated by adding beginning inventory to ending inventory and dividing that result by 2.
The COGS is obtained by multiplying the turnover ratio by the average inventory.
Calculating Ending Inventory Using FIFO
We already explained what the FIFO (First In, First Out) method is above, but how can you use it to calculate the ending inventory?
Let’s suppose that your online store sells Bluetooth headphones with SKU-123. During the month of October, you made 3 purchases of different products of the same market variation.
On October 8 you bought 100 units at €20 each.
On October 19 you bought 150 units at €25 each.
On October 22 you bought 200 units at €30 each.
How do you calculate the ending inventory?
When using the FIFO method, the first units in are the first out. This means that the first 300 headphone sales will start with the units that were bought first.
- The first 100 units come from the October 8 purchase at €20 each. The total is €2,000.
- The next 150 units are from the purchase of October 19 at €25 each. The total is €3,750.
- The last 50 units come from the purchase of October 22 at €30 each. The total is €1,500.
The remaining stock is 150 units from the purchase of October 22 at €30 per unit.
In this case, the ending inventory would be €4,500, calculated by multiplying the cost of €30 by the amount of 150 units of stock.
Managing Negative Ending Inventory: Causes and Solutions
Negative ending inventory occurs when records indicate that more items have been sold than are available in stock.
This is usually the product of a number of factors that will be explained below but that affect not only the ending inventory but also the business’s finances and accounts.
We said earlier in this article that it is important to optimize resources to keep everything related to the movement of merchandise organized.
The most common causes of negative ending inventory
Errors in purchase records: A very common situation is human failure when entering the purchase from a supplier, which can result in a discrepancy between the actual stock and the one recorded in the system.
Inventory count mismatches: Another common factor that can result in a negative ending inventory is an error in the counting process or damaged or stolen products that also affect the current stock.
Sales not recorded correctly: Whether due to a billing error, human error or even software problems, it is also possible that sales are not recorded correctly and cause an inventory mismatch.
Impact on financial statements
The errors mentioned above can lead to inaccurate results that affect the perception about the business’s profit or loss.
For example, when ending inventory is negative, it can be perceived as a business profit and generate misleading results that have nothing to do with the way things really are, and this could lead to wrong decisions that affect the course of the store.
Also, keep in mind that poor inventory management can also affect the bottom line, including liquidity and cash flow.
Practical solutions and improvements
To improve this financial impact, you can adopt different measures that provide solutions and improve the operation and fluidity of the ending inventory, not only to correct errors but also to avoid repeating them.
One of the best ways to avoid negative inventories that directly impact the financial status of the business is to periodically perform an inventory reconciliation. That is, manually compare the current state of the stock with what is recorded in the system. This can be done on a monthly, bimonthly or biannual basis, depending on the number of references.
This is one of the best ways to manage the stock of a store, not only providing an accurate count but also optimizing your time by updating the product stock automatically after each sale. cómo calcular el margen con la calculadora COD.
At Beeping we have world-class software that will adapt perfectly to your business and that you can easily integrate to your Shopify store with a single click.
Having qualified, trained and experienced staff in inventory management will also be essential to solve the problems that may arise.
Conclusion
Up to this point, we have reviewed what ending inventory is, why it is essential to know how to manage it and, above all, what to do in an unfavorable scenario.
Correctly applying the general formula and its variants will allow you to keep your business optimized and up to date in terms of financial information.
Keep in mind that the management of the ending inventory in an ecommerce business has a direct impact on the resources of your store and even on customer satisfaction.
Therefore, as we have seen throughout the article, it is essential to correctly use methods like FIFO, LIFO or weighted average cost to offer a perspective that fits the dynamics of your business.
At the same time, technology is a key factor and in that context Beeping’s software can be a fundamental ally thanks to its accuracy and reliability.
In short, we encourage you to implement the practices explained throughout the article to help ensure the most accurate ending inventory possible, ultimately improving customer satisfaction in your business.
FAQ
Can ending inventory methods be changed mid-year?
We do not recommend it. Changing any aspect of inventory valuation can directly affect the business and create inconsistencies that require quick action to avoid major problems.
How does ending inventory impact cash flow in ecommerce?
As we have explained throughout the article, ending inventory directly influences cash flow because poor management affects the amount of capital available from unsold items.
On the other hand, managing inventory efficiently will allow you to reinvest that cash flow to free up financial resources.
What's the impact of incorrect ending inventory on tax liabilities?
In a chain reaction, an incorrect ending inventory could result in a miscalculation of the cost of goods sold (COGS), which would affect gross margin and ultimately result in an incorrect tax return.
This could cause an overpayment in tax liabilities as penalties for failure to do so.
2 thoughts on “Master Ending Inventory to Boost Profit & Avoid Losses”
Hello! The article provides a clear overview of how to calculate ending inventory, but what tools or software do you recommend to make this process easier and minimize errors?
Thank you for your comment! To make calculating ending inventory easier and reduce errors, an excellent tool you can use is Beeping Fulfillment software. This system enables automated inventory management, making it easier to track products, control real-time stock levels, and integrate with your online store. With constantly updated data, you can perform accurate ending inventory calculations and make more informed decisions to optimize your business. In addition, Beeping Fulfillment helps you reduce operational costs and improve logistics efficiency.