The basic formula to calculate ending inventory is beginning inventory plus purchases minus cost of goods sold. Although the number of units in ending inventory won't be affected, the inventory valuation method a business chooses affects the dollar value of ending inventory. First in, first out will create a higher ending inventory in a time or rising prices while last in, last out creates a lower one.
Ending Inventory Formula
The formula for ending inventory is beginning inventory plus net purchases minus cost of goods sold. Net purchases are purchases after returns or discounts have been taken out. For example, say a company began the month with $50,000 worth of inventory. During the month, it purchased $4,000 more inventory from vendors and sold $25,000 worth of product. Ending inventory for the month is $50,000 plus $4,000 minus $25,000, or $29,000. This calculation can also be used to calculate ending inventory in units. For example, say a company starts the month with 50 units of inventory, purchases another 4 units of inventory and sells 25 units of inventory. Ending inventory is 50 plus 4 minus 25, or 29 units.
Inventory Valuation Methods
The biggest factor that affects the dollar value of ending inventory is the inventory valuation method that a company chooses. As vendors experience shortages and surpluses, they may offer products to customers at different prices. The customer might also be able to obtain discounts for purchasing in bulk or pay extra fees for rush delivery. Also, when the economy experiences inflation, prices tend to rise across the board. All this changes the price of each individual unit of inventory. The business then chooses an inventory valuation method to account for changing costs.
Ending Inventory Under FIFO
Under the "first in, first out" method -- FIFO, for short -- the business assumes that the oldest inventory is the first inventory sold. In a time of rising prices, this means that ending inventory will be higher. For example, say that a company bought 1 unit of inventory for $20. Later, it purchased 1 unit of inventory for $30. If it now sells 1 unit of inventory under FIFO, it assumes it sold the $20 inventory. This means that cost of goods sold is only $20 while remaining inventory is valued at $30.
Ending Inventory Under LIFO
As an alternative to FIFO, a company may use "last in, first out," or LIFO for short. The assumption under LIFO is that the inventory added most recently is the inventory sold first. In contrast to FIFO, choosing LIFO will create a lower ending inventory during a period of rising prices. Taking the information from the previous example, a company using LIFO would have $30 as cost of goods sold and $20 in remaining inventory.
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