Calculating your closing inventory is more than just a routine accounting task, it's a vital process that directly impacts your bottom line. Whether you’re overestimating or underestimating your stock levels, the consequences can ripple through your entire business. From financial statements that don’t reflect reality to tax liabilities that creep up unexpectedly, inaccurate inventory calculations can disrupt your operations, leading to poor stock management, missed sales, and increased costs.

Understanding how to accurately determine closing inventory is key to staying on top of your finances and keeping your business running smoothly.

In this post, we’ll walk through various methods to help you calculate closing inventory and explore the importance of using these figures to make informed decisions about reordering and stock management.

We’ll also introduce you to Warehouse Management Systems (WMS) like StoreFeeder, which streamline this complex process by automating inventory tracking and reporting. With the right tools and techniques, you can ensure accurate financial data, avoid stock mishaps, and keep your online store thriving.

What is Closing Inventory and Why It’s Important

Closing inventory is the value of the inventory a business holds at the end of an accounting period, including any unsold goods. You can think of it as leftover products in an ecommerce store’s warehouse at the end of the quarter or year.

Why It’s Important

Calculating closing inventory is essential for numerous reasons.

The primary motivation is profitability. Calculating closing inventory affects the Cost of Goods Sold (COGS), which in turn impacts gross profit and net income in margin calculations. Businesses with unsold inventory can subtract this figure from their COGS, reducing taxable income.

As such, closing inventory also plays a key role in the preparation of balance sheets and income statements, reflecting the value of unsold goods. Ending inventory is a current asset on the balance sheet, with a higher figure increasing total assets, and a lower one reducing it. Companies with higher COGS can reduce closing inventories and write off more tax.

Finally, closing inventory insights are critical because they enable firms to make better reordering and business decisions. Accurate readings inform stock replenishment judgments and help avoid overstocking or stockouts.

How Closing Inventory is Used and Who Uses It

Businesses use closing inventory in several ways, with the first being in the realm of financial reporting. Inventory estimates are critical in calculating COGS, which is needed to prepare income statements and determine net profit.

Closing inventory is also crucial for tax filing since it impacts the tax paid. Over, or undervaluing inventory can skew reported profits and taxes owed.

There are also operational benefits. Businesses can use closing inventory to determine:
⦁ How much to reorder
⦁ Which products are underperforming
⦁ When to launch promotions, markdowns, or discontinuations

For example, if a product is underperforming, the company could stop ordering it and replace it with another line doing well.

Several stakeholders rely on closing inventories to inform their accounting and business decisions. For example, ecommerce business owners rely on ending inventories to monitor their profitability and manage stock levels. Keeping track of items secured in their warehouses improves buying decisions and helps with demand forecasting.

Warehouse managers can benefit for similar reasons. Ending inventory figures tells them more about their hard-to-move stock and why it won’t shift.

Besides direct operations, accountants and finance teams benefit from ending inventory data. These professionals rely on the figures to prepare financial statements and ensure accurate tax reporting.

Finally, investors and stakeholders require closing inventory data to assess corporate performance. Accurate figures reveal more about the financial health of the underlying business.

Methods to Calculate Closing Inventory

So, how do you calculate closing inventory? There are several methods you can use. Each offers a slightly different emphasis, depending on the available data and the principles you want to use for your calculation.

1. Formula for Closing Inventory

Learning the general formula for closing inventory levels is often the first step. Once you understand the formula, you are in a better position to start calculating this metric using different methods.

The general formula is:

Closing Inventory = Opening Inventory + Purchases During Period – Cost of Goods Sold (COGS)

This equation looks complicated, but it breaks down neatly into the following:

⦁ Opening Inventory: The stock’s value at the beginning of the accounting period.
⦁ Purchases During Period: The total cost of additional inventory purchased during the period.
⦁ Cost of Goods Sold (COGS): The direct costs associated with producing the goods sold during the period.

For example, an ecommerce firm might buy stock at the start of the period, say 1,000 shampoo bottles. Then, it might add another 200 to its overall purchases during the period, taking the total to 1,200.

To calculate its closing inventory, the firm must determine the COGS and subtract it from the previous result. This figure includes all the costs associated with selling, including warehouse rent, labour costs, and overhead costs. The final figure gives more information about the brand’s net asset position.

Numerical example:

If your opening inventory is £10,000, purchases during the period are £7,000, and COGS is £12,000, then:

Closing Inventory = £10,000 + £7,000 - £12,000 = £5,000

2. FIFO (First In, First Out) Method

The FIFO (First In, First Out) method is different. Under the FIFO method, the first items added to inventory are the first ones sold, meaning the ending inventory consists of the most recently purchased or produced items.

The purpose of the FIFO method is to ship older inventory out before newer items arrive, allowing companies to keep better track of the prices or values of each SKU for more accurate estimations. Firms using FIFO often have a clearer idea of the COGS embodied in each sale (which can become clouded if some items remain in inventory for a long time).

The formula for the FIFO method is as follows:

Closing Inventory = Cost of Most Recent Purchases × Quantity of Remaining Inventory

Numerical example:

If the first batch of inventory was purchased at £10/unit, and the second batch was purchased at £12/unit, with 100 units left in stock, then closing inventory would be calculated using the most recent price (£12/unit):

Closing Inventory = 100 units × £12 = £1,200

3. LIFO (Last In, First Out) Method

The LIFO (Last In, First Out) method takes a different approach. Under the LIFO method, the most recently purchased items are sold first, leaving the older inventory in stock for the closing inventory calculation.

The LIFO method can sometimes lower a company’s tax obligations by shifting high-cost inventory to the COGS, reducing taxes paid. However, it is not compatible with international accounting standards and can artificially lower a company’s balance sheet valuation (because older, outdated goods remain on the balance sheet).

The formula for LIFO closing inventory is:

Closing Inventory = Cost of Oldest Purchases × Quantity of Remaining Inventory

Numerical example:

If the first batch of inventory was purchased at £10/unit, and the second batch was purchased at £12/unit, with 100 units left in stock, then closing inventory would be calculated using the oldest price (£10/unit):

Closing Inventory = 100 units × £10 = £1,000

4. Weighted Average Method

The Weighted Average Cost (WAC) method is another approach you sometimes see ecommerce companies use. This calculates closing inventory by averaging the cost of all inventory purchased during the period and applying this average cost to the remaining units in stock.

The WAC is allowed under Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). And because of how it’s calculated, companies dealing with goods with fast-changing prices find it helpful.  

Here is the formula for the WAC:

Weighted Average Cost Per Unit = Total Cost of Goods Available for Sale ÷ Total Units Available for Sale
Then you can plug this result into the following equation to calculate the closing inventory:

Closing Inventory = Weighted Average Cost Per Unit × Quantity of Remaining Inventory

Numerical example:

If you have 200 units purchased at different costs, with a total cost of £2,000, then the weighted average cost per unit is £10:

Closing Inventory = 100 units × £10 = £1,000

5. Retail Inventory Method

The Retail Inventory Method is another highly popular approach. It estimates the value of closing inventory based on the cost-to-retail ratio, often used by retail businesses that track inventory at retail prices.

The cost-to-retail ratio divides the cost of goods available by the retail value of those goods, giving the ratio of expenses to revenues embodied in each product. This information can then be fed back into the closing inventory calculation, providing a suggestive value for the remaining inventory.

This method is popular in the ecommerce industry but requires keeping detailed records. Companies must assume the same markup across products. If it changes, then the final calculation will change.

The retail inventory formula is as follows:

Closing Inventory = (Total Goods Available for Sale – Sales) × Cost-to-Retail Ratio

Numerical example:

If your goods available for sale are £20,000, sales are £12,000, and your cost-to-retail ratio is 60%, then:

Closing Inventory = (£20,000 - £12,000) × 0.60 = £4,800

6. Gross Profit Method

The Gross Profit (GP) method is our final approach to calculating closing inventory. It estimates closing inventory by applying the gross profit percentage to sales, which helps estimate the cost of goods sold (COGS).

The GP method is useful when companies are dealing with limited information. It only requires three pieces of information: goods on hand, sales over the accounting period, and the gross profit percentage.

The downside is the inaccuracy. Profit margins may change and may not reflect variations between specific SKUs.

The closing inventory formula under the gross profit method is:

Closing Inventory = Goods Available for Sale – (Net Sales × (1 – Gross Profit Percentage))

Numerical example:

If your goods available for sale are £25,000, net sales are £15,000, and your gross profit percentage is 40%, then:

Closing Inventory = £25,000 – (£15,000 × 0.60) = £16,000

How StoreFeeder’s WMS Can Help with Calculating Closing Inventory

Calculating closing inventory is complex. However, StoreFeeder’s Warehouse Management System (WMS) can help. It simplifies the process using several processes, helping you avoid complex calculations.

For example, StoreFeeder automatically tracks inventory levels across multiple channels and warehouses, ensuring accurate data for inventory calculations. Real-time tracking allows you to watch goods in transit in and out of your facilities, allowing you to take measurements at the unit level (instead of using estimates or averages).

StoreFeeder also automates report generation, providing insights into stock levels, COGS, and ending inventory values. This technology reduces the risk of human error and saves time.

Finally, StoreFeeder’s superpower is its multi-channel integration. The software allows you to seamlessly manage inventory from multiple sales channels (e.g., Shopify, eBay, Amazon), ensuring consistent and accurate data for closing inventory calculations. You can collate data business-wide to attain reporting compliance.

Best Practices for Accurate Closing Inventory Calculation

Here are some actionable tips for ensuring accurate closing inventory calculations:

⦁ Conduct Regular Inventory Audits: Check stock levels manually to verify the accuracy of your inventory and reconcile any discrepancies.
⦁ Update Inventory in Real-Time: Ensure that all stock movements (sales, returns, damages) are updated in real-time using a WMS like StoreFeeder. Keep tabs on your true financial position instead of estimating it at the end of long accounting cycles.
⦁ Use Technology for Automation: Automate the inventory management process to minimise human error and ensure inventory levels are accurate across all sales channels. Leverage data to forecast demand and place sensible orders with suppliers.

Conclusion

In summary, accurate calculation of closing inventory is critical for understanding your store’s profitability. Ensuring correct financial reporting and making informed stock decisions improves outcomes for staff, leaders, and stakeholders while maintaining compliance.

While closing inventory calculations are complex, using a Warehouse Management System (WMS) like StoreFeeder can automate much of this process. Solutions provide real-time insights into your inventory and ensure accurate reporting.

We suggest exploring how StoreFeeder can help you streamline inventory management and maintain accurate financial records today. Using such tools reduces stress and headaches for staff and gives you a clearer picture of your financial position at any given time.

So, what are you waiting for? Book a StoreFeeder demo to see how this WMS can automate inventory tracking and ensure accurate closing inventory calculations.