Ending inventory is a significant factor in your eCommerce business’s inventory accounting process. Ending inventory is part of your calculations for how much you sell during an accounting period and how to best manage your inventory for the next one.
Therefore, knowing what ending inventory is as well as the methods for calculating it can improve your accounting methods and help you choose the right accounting software for your eCommerce business. In this article, we go over:
- What ending inventory is
- Why ending inventory is significant in eCommerce
- How to calculate ending inventory
- How 3PL services help
What is Ending Inventory?
After each accounting period, you will still have sellable inventory that must be accounted for in the next period. This is called your ending inventory, which is calculated in terms of its sellable value.
To calculate your COGS or cost of goods sold for a given accounting period, you must know the ending balance of your remaining inventory for that period. Since all inventory must be claimed as an asset on your company’s balance sheet, the ending inventory calculation directly impact your accounting, which in turn affects your business’s taxes.
Therefore, ending inventory calculations are a significant aspect of your yearly tax reports as well as your ordering schedule for each accounting period. In other words, you can’t know what to buy if you don’t know the value of what you already have.
The Importance of Ending Inventory in Ecommerce
Until your business’s inventory is sold, it represents a cost that your business pays each accounting period. This makes unsold inventory at the end of each period, the ending inventory, a significant number to calculate properly.
Here are just a few reasons why ending inventory is important for your eCommerce business:
Revenue calculations help you understand your net income. If you find that you are paying more for goods than the sum of their market value in a given accounting period, your item pricing, shipping methods, or supplier may need to change.
You will not be able to make these decisions without accurate ending inventory numbers because they tell you how your real and recorded inventories compare, helping you calculate your cost of goods sold.
Your inventory balance sheets should always line up with the contents of your business’s warehouse. Verifying what you still have in stock at the end of your accounting period is important for a few reasons. The first is accurately calculating revenue, which we already discussed.
The second is discovering discrepancies between the value of your reported inventory at the end of the accounting period and the expected value of the inventory that should be left after subtracting everything that sold. Differences in these values could indicate any number of errors in your process, including accounting mistakes or even theft.
Documentation and reporting
Ending inventory represents a significant aspect of documentation for eCommerce businesses. Tax accounting requires accurate ending inventory. Additionally, businesses that seek financing will also need to keep accurate ending inventory numbers.
There is more to financial reporting than just taxes, however. Your internal business reports also rely on accurate inventory numbers since beginning inventory calculations use ending inventory as their starting point.
Ending Inventory Formula
Regardless of which method you use to calculate your ending inventory, there are a few terms that every business needs to be familiar with to do so accurately.
Beginning inventory – This is the inventory calculation from the previous accounting period. For the current period, beginning inventory represents the total goods that you had in stock when the accounting period started.
Net purchases – During the current accounting period, all products added to your inventory should have their costs added up to equal your business’s net purchases.
Cost of goods sold – Also known as COGS, the cost of goods sold is everything your business must spend to sell an item. This includes buying the product, manufacturing it, and more before it’s ready to be sold on your site.
These three terms together can be used to form the ending inventory formula:
Beginning Inventory + Net Purchases – Cost of Goods Sold = Ending Inventory
This formula has a certain logic to it. The value of what you started with, plus the value of everything you bought, minus the cost of everything you sold, should equal what you have left for the next accounting period.
As discussed, however, this number is not always the value of your business’s ending inventory – it is only what the value should be. You must calculate the ending inventory using other methods to confirm that the actual value of the products you have left is equal to the value you should have left after factoring in the costs.
To do that, we have laid out several methods that businesses can use to calculate the value of their actual ending inventory.
Methods for Calculating Ending Inventory
Though these methods are effective on their own terms, they calculate ending inventory differently. This means that it’s important to select the calculation method that works for your business, as well as to continue using the same method consistently to avoid discrepancies later.
The gross profit method uses the gross profit margin to find the ending inventory. This is equal to your Net Sales per accounting period minus your COGS.
First, you must add up everything that you had available for sale in your inventory, which would be your beginning inventory plus your purchases during that accounting period. Then, calculate the total cost of the goods you sold by multiplying your gross profit margin by your sales. To arrive at your ending inventory, subtract your estimated COGS from the total cost of products available for sale during that period.
This method works so long as your gross margin remains the same. Inventory calculations will become inaccurate if the margin itself changes drastically.
Businesses that only sell a few SKUs can take advantage of the weighted average method of calculating ending inventory. It calculates it by dividing the total cost of your current inventory by the number of items you currently have in stock. The resulting number represents the average cost of your goods during that period.
For many companies, this method is the simplest to use. Consider a business with 500 products at the beginning of the accounting period, each valued at $3.00. During that period, assume you purchased 100 more for $4.00 each.
This means that using the weighted average method, assuming you made no additional purchases, your business’s ending inventory would be 600 items valued at $3.50 each or $2,100.
First In, First Out
The First In, First Out method (or FIFO) allows you to calculate ending inventory under the assumption that you will sell your oldest items first to keep the inventory new, even if the prices have changed.
To use this method, add the costs of your most recent product purchases to your previous COGS assessment to find your ending inventory. In periods of high inflation or price changes, the FIFO method will yield an ending inventory that is worth more.
For example, if a product doubles in price between the first time you bought 10 of them and the second time, you may have sold the earlier priced products first. But you will calculate your ending inventory using the product’s current value.
Last In, First Out
Last In, First Out (LIFO) is more or less the opposite of the FIFO method. This time, the calculations assume that your most recent purchases were sold most recently.
This may oppositely result in an ending inventory of lower value since it is calculated using the most recent prices first. However, in a period where the cost of your product purchases decreased, LIFO may be advantageous.
How 3PLs Help with Ending Inventory
3PLs provide many services that can help businesses choose the right calculation method for their accounting needs. They integrate inventory management software into a business’s infrastructure to help it make more informed buying decisions as well as more accurate accounting calculations.
In addition to inventory management, 3PLs also equip businesses with reporting tools that examine a business’s sales frequency, demand forecast, and even SKU-specific sales records to further optimize your buying and selling decisions.
3PLs combine sales data, accounting history, and product demand forecasts to bring your fulfillment process up-to-date statistics that can inform its future buying and selling decisions.
The Takeaway for Ecommerce Businesses
Ending inventory is a significant aspect of accounting, both for buying and selling decisions within an accounting period as well as for tax purposes. While each method for calculating inventory has advantages, a third-party fulfillment company skilled in using them can choose the method most advantageous for your business.
Contact eWorld Fulfillment to learn about the fulfillment, inventory management, and technology solutions we can offer your eCommerce business.