Managing a business and sustaining its success and profitability can be a significant challenge. Where many consider employees to be their greatest asset – which, of course, is right – they cannot overlook the importance of beginning inventory.
To promote and upkeep financial health for any type and size of business, entrepreneurs and business owners need to be aware of inventory and learn the correct formulas for its calculations.
If not for the inventory, how do you think the businesses will evaluate the demand and determine the potential profitability of their products if they have yet to learn about the quantity they have in hand and the amount they need to order?
Moreover, the beginning inventory for any business helps them estimate other important aspects of the financial condition, such as the turnover rate for merchandise and even COGS, the cost of goods sold.
Therefore, if you are starting a new business or want to manage your inventory, here is a stepwise get on calculating the beginning inventory and its importance for your business!
Guide On How To Calculate Beginning Inventory
Beginning inventory, or as you can call it, the “opening inventory,” is the actual cost of inventory that is in a business’s accounting record when an accounting period starts. This means that when a preceding accounting period ends, the in-record cost of stock flows into the next accounting period as it begins.
Let us simplify: You will calculate your beginning inventory when the new accounting period starts. The beginning inventory is an asset account specified as a current asset for any business.
Technically speaking, the beginning inventory does not exist on the balance sheet. The reason is that the balance sheet is usually created on a specific date and time – often at the closing of the accounting period. But, if we rewind a little, the beginning inventory immediately precedes a new accounting period – so it is on the balance sheet but not classified.
As you can see, the beginning inventory is a core fundamental of inventory accounting, so it is crucial to maintain its calculations.
If the entire math confuses you, and you have no idea how to calculate the beginning inventory – worry not! We are here to help!
The Importance Of The Beginning Inventory
If you want to track your business performance and utilize the statistics for better financial progress in the future, you have to compare the beginning inventory period over different times. Not only will it give you better insights into your business areas, such as inventory value and turnover rate, but it will also help you in many other ways, including:
1. Keep an eye on the fluctuations in inventory demands.
If you have been tracking and comparing your beginning inventory, and you see a shift in finances – it tells you about the demand for sales, products, and clients. For instance, if your beginning inventory count decreases, your sales were good in the last month compared to the last time.
Subsequently, suppose your beginning inventory remains static over a few months or increases in the count. In that case, your business is not growing at a reasonable rate – indicating that you need to up your game!
2. Helps you identify the issues in inventory management
If there is low or no beginning inventory at the start of a new accounting period, your company might have over-ordered the merchandise in the last period. It can also result in a more significant number of units left behind, helping you identify a breakdown in your inventory management process because an insufficient amount needed to be ordered for the stock.
You can ensure seamless and progressive inventory management with timely comparisons and checks on the beginning inventory.
3. Indicates any loopholes in the supply chain
The beginning inventory will tell you about your stocks – whether you have fewer or more units. An irregular pattern can indicate issues with the supply chain. If everything on your business part, sales, and finances look good, but you still have lesser units than usual, it might be because the supplier did not fulfill or deliver your inventory purchases properly.
4. Eliminates the chances of shrinkage
Shrinkage happens when there is an inconsistency in the value of how much inventory was recorded instead of what should have been recorded. This can occur for many reasons, such as damaged products, stolen goods, or human error.
If this happens to you, it will help you keep an eye out to ensure that your employees are not stealing the merchandise causing the shrinkage.
5. Helps you with your taxes
When you consistently keep a check and calculate your inventory – comparing it monthly – you can estimate an average accounting period. It can help you pre-purchase the inventory and, as a result, reduce your taxable income.
Therefore, you have maintained your beginning inventory, sales look good, and you have lowered the tax you owe – a complete win-win.
How Can You Calculate Beginning Inventory?
Here is how to calculate the beginning inventory using a simple formula.
Beginning inventory = (Cost of goods sold (COGS) + Ending inventory) – Purchases
Let us break down each step ad simplify the calculation.
Evaluate the cost of your sold gods – the COGS- using the previous accounting period’s data.
COGS = (Beginning inventory for previous accounting period + purchases during the last accounting) – ending list in the previous accounting period
Now, multiply the balance for ending inventory by the production cost for every item. Repeat this with the amount of new inventory.
Ending inventory = (Beginning inventory in the previous accounting period beginning inventory + Net purchases for the new period) – COGS
Add the ending inventory to the COGS. (Look at the formula for calculating the ending inventory given above).
Subtract the amount for inventory purchased from the number you obtained in “step 3,” and you will get the value of your beginning inventory.
Pro tip: If you manually use this formula to calculate the beginning inventory, double-check because math can often be confusing! Any error in the calculation for the beginning inventory creates a domino effect of a series of miscalculations that can mislead you and negatively influence your future decisions.
An example to help you calculate the beginning inventory
Here is an example for you to help you develop a better understanding of the beginning inventory formula:
- Evaluate the COGS by using the data in previous records of the accounting period.
Example: Socks cost $2 each to produce, and John’s Comfort sold 800 pairs during the year.
COGS = 800 x $2 = $1,600
- To calculate your balance for the ending inventory, utilize your accounting records and the amount needed/used for the new inventory produced or purchased during this period.
Example: John’s Comfort had 1000 pairs of socks in the inventory when the preceding accounting period ended and produced another 1,200 pairs the next year.
Ending inventory = 1000 x $2 = $2000
New inventory (purchased) = 1,200 x $2 = $2,400
- You need to add the ending inventory and cost of products sold.
Example: $2,000 + $1,600 = $3,600
- To calculate the beginning inventory, you have to subtract the amount purchased from the result in step 3.
Example: $3,800 – $2,400 = $1,400 (this is your beginning inventory that goes into the new accounting period)
Seamlessly Maintain Your Beginning Inventory – Now Is The Time!
Learning how to calculate the beginning inventory is an essential tool that empowers businesses to understand their operational trends and sales in a better way. When you calculate it rightly, you can utilize this data to make your strategies for inventory management better and more productive. Moreover, better-beginning inventory methods help the business optimize inventory costs and increase gross profits.