Determining the ending inventory of a business is for experts a very common issue. However, many people who are not quite familiar with this aspect may find it a little bit confusing. For this reason, this article aims at providing some information for those who do not run businesses, but who are interested in this field of activity. For a better understanding, the ending inventory represents the amount of money that has been spent for buying goods and materials that are in stock at the end of every fiscal year. Another concept that is strictly related to this one is beginning inventory. Beginning inventory measures the value of goods that are in stock at the beginning of every fiscal year. It should be known that every ending inventory of a year becomes the beginning inventory of the year to come.

Every businessman relies a lot on these two types of inventory because they are helpful to forecast sales and to analyze the situation of his affairs by establishing which goods are worth buying and selling and which goods do not bring any or less profit. The ending inventory can be determined by using the following formula: beginning inventory + the purchases made during a certain year – the costs of the goods sold. Nevertheless, we can use this formula to calculate other things, especially to calculate cost of goods sold, to calculate net purchases or to calculate the beginning inventory.

In addition to this, the ending inventory is calculated differently for a retailer than for a manufacturer. Manufacturers can either have their units finished or can establish the inventory of raw materials and work in process (products that are completed partially). Also, they must take into consideration some variables when determining the total cost per unit. Unlike retailers or service providers who only pay for the goods they purchase and the fees for shipping, manufacturers do not buy finished goods, but they rather buy raw materials and transform them into finished products. Besides raw materials, manufacturers have to pay for the labor (the wages received by employees, the taxes paid for Social Services etc.) and factory overhead.

The situation is the same when wanting to calculate cost of goods sold. If you are a retailer, you only have to take into consideration the prices paid for the goods you bought and shipping. On the other part, if you are a manufacturer, you must pay attention to multiple aspects, such as the inventory at the beginning of the year, the raw materials bought during that year, direct labor costs, factory overhead costs, costs of goods ready to be sold and the inventory at the end of the year. Due to the fact that the greatest majority of business and companies have various prices for each piece of inventory, inventory valuation represents an important part of establishing inventories, both beginning and ending. There are three different ways to valuate inventories: FIFO (first in, first out), LIFO (last in, first out) and average cost.

In conclusion, in order to prevent failure in their businesses, companies have to give estimations about their inventories and about the way to calculate cost of goods sold. The good aspect is that there are two important methods to do this: the gross profit method and the retail inventory method. The gross profit method establishes the value of the inventory by looking at the profit previously made by the company. On the other side, the retail inventory method is based on estimations about retail sales price of inventory. So, in case you want to visualize the situation of your business at the end of the year, you should try with confidence these two methods.
Have you ever used one of these two methods to estimate your ending inventory? How do you calculate cost of goods sold, as a manufacturer or as a retailer?