Good inventory management can make the difference between a profitable and an unprofitable business year. The cost of inventory is included in the line item "cost of goods sold," found on the income statement. Cost of direct materials is often used to calculate inventory turnover ratios, but managers also use it to calculate the annual inventory cost. This calculation can help accurately estimate total cost of production in budget projections.
Obtain the value of direct materials inventory at the beginning of the year. For this example, assume an opening direct materials inventory of $10,000.
Calculate the cost of all direct material inventory sold throughout the year. This is the cost to purchase the inventory. Assume you sold a total of $50,000 in direct materials for the year in this example.
Obtain the closing direct materials inventory for the year. This is the value of direct materials inventory at the end of the year. Assume the value of inventory at the end of the year on the example balance sheet is $5,000.
Calculate total direct materials inventory cost for the year. Subtract the value of inventory from the beginning of the year from the value of inventory at the end of the year and then add the total cost of goods sold. The calculation for this example is $5,000 minus $10,000 plus $50,000. The answer is $45,000
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- Masao Nakamura, Sadao Sakakibara and Roger Schroeder. "Adoption of Just-in-Time Manufacturing Methods at U.S.- and Japanese-Owned Plants: Some Empirical Evidence," pages 230-231. IEEE Transactions on Engineering Management, 1988.
- Electronic Code of Federal Regulations. "Regulation S-X, 17 CFR Part 210: Sec. 210.5-02 Balance sheets." Accessed Aug. 1, 2020.
James Collins has worked as a freelance writer since 2005. His work appears online, focusing on business and financial topics. He holds a Bachelor of Science in horticulture science from Pennsylvania State University.