How to Calculate Beginning Inventory
As an entrepreneur, you are either providing services or selling tangible products to consumers. But you can still run a business that is a blend of the two categories.
Either way, you play a great role in adding value to the lives of the consumers whether they are individuals or other enterprises.
Nonetheless, the modes of operation for these two kinds of businesses are completely different.
When the backbone of your company is service provision, you may not need to worry about keeping records like inventory or any other stock details.
Your main focus will be ensuring that you or your team is well-trained and skilled to give your clients top-quality service.
Loosely speaking, that would imply the level of your skill is the size of your inventory. This, however, cannot be accurately quantified if not in reference to the charge rates.
On the other hand, businesses that deal in physical goods, whether they are finished products or raw materials, must have their inventories up-to-date at all times.
So, let’s take a close look into the concept of inventory.
What is an inventory?
First, we appreciate that a company dealing in goods can either be a manufacturing plant or a retail business. For the former, numerous items are essential for the production process.
These include machines and their accessories plus other consumables which may be used for the maintenance of the machinery or administrative purposes.
Such consumables include oil for greasing machines, stationery for administration, and many others. Besides, there are raw materials that are the primary elements of the manufacturing process. These vary depending on the items you produce.
But what do you consider as a raw material? Anything that goes into the manufacturing process and forms a distinct part of the end product.
Again, there are kinds of stuff that are neither raw materials nor finished products but form a vital part of the production. These are generally referred to as work in progress. Lastly, there are finished products which you take out to the market. Ideally, they are the primary reason why the manufacturing firm exists.
Assuming you run a retail business, you may only be handling finished products with extremely few value addition undertakings before selling them to consumers.
Notwithstanding, one question is apparent whether you are a retailer or a manufacturer. ‘What do you include in the inventory when it comes to accounting?’ Do you count the machines plus their accessories? What about the raw materials and the work in progress?
These are the questions we answer as we unravel the concept of inventory.
The Concept of Inventory
Inventory entails the complete goods together with everything else that directly forms part of the end product used by the consumers.
For instance, raw materials and work in progress will be counted in the manufacturer’s inventory while the retailer will only count the finished products in the inventory. Because of this, production companies have three categories of inventories; finished items, work in progress, and raw material.
What about the machines? So you ask.
Though they are important for production, they do not go into the final good. For instance, if you are a manufacturer of fruit juice, spotting machine grease in your product would cause a great uproar among consumers.
Consequently, such items are not counted in the inventory. But we can’t belittle the value of oil in the operation of various equipment.
Despite the type of business, two kinds of inventory are necessary for accounting purposes; opening inventory, widely known as beginning inventory, and closing inventory or ending inventory.
Beginning inventory is the focus of this discussion with a keen eye on how it is calculated.
What is the Beginning Inventory?
It refers to the value of a business’ inventory at the start of an accounting period. In other words, it is what a company’s accounting records reveal that it has and can be utilized for revenue generation at the beginning of a specific accounting term.
You can also define opening inventory as the closing inventory at the end of an accounting year immediately preceding the current one. The ending inventory is simply carried forward from the last period and used in the present period as the beginning inventory.
Since the opening inventory will be utilized either in part or wholly during the current accounting period, it is a company’s current asset. However, it never appears directly on the balance sheet because the balance sheet only contains assets available at the close of an accounting period. Notwithstanding, the ending inventory is always present on the balance sheet.
From the definition, this implies that beginning inventory appears though with a different name.
What is the significance of beginning inventory?
Calculation of the cost of goods sold (COGS)
When calculating the cost of goods sold, whether as a retailer or a manufacturer, opening inventory is a fundamental part of the equation. Ideally, it is the starting point as you add all the purchases made to the beginning inventory of that given then less the closing inventory. This formula for COGS calculation applies to the retail companies. For the manufacturing firms, the process is a bit complicated as work in progress is involved.
Determination of average inventory
Calculation of a business’ average inventory in a particular accounting period is the second important use of opening inventory. Do you want to know the value of your inventory at any given time of the year? You will need the beginning inventory in the financial analysis to determine inventory turnover.
Besides inventory turnover, numerous other financial metrics can be calculated using either the closing inventory or beginning inventory. However, the opening inventory gives a more accurate average compared to instances where ending inventory is used. This is true especially in the cases the closing inventory is abnormally low or high.
Indicator of the quantity of dead stock
Beginning inventory is the best indicator of the amount of dead stock you a company may have. When dealing with perishables, a high opening inventory shows that the risk of losses in that period is quite high.
Lastly, this inventory helps you determine whether your business has sold more or not. This is revealed in comparison to the ending inventory.
Step by Step Calculation
- Step 1: Calculate the COGS by using the accounting record of your previous accounting period
- Step 2: Multiply the balance of the ending inventory with each item’s production cost.
- Step 3: Repeat step (2) above with the amount of the new inventory.
- Step 4: Add the COGS to the ending inventory
- Step 5: Calculate your beginning inventory by subtracting the inventory purchased amount from the result in step (4) above.
Still not getting it? Mmmh, maybe an example will help!
Determining COGS using the record of your previous accounting period
A manufacturing company produces and sells candles. Each candle has a production cost of $3. During this year, the company sold 700 candles. What is COGS?
COGS = 700 x $3 = $2100
Determine the balance of the ending inventory and the total amount of the new inventory produced or purchased during a certain time period.
The manufacturing company had 900 candles which was the total remaining stock present at the end of the earlier accounting period. This company further produced 1000 candles in their next year of production.
Ending inventory = 900 x $3 = $2700.
New inventory = 1000 x $3 = $3000
Ending inventory + COGS = $2700 + $2100 = $4800
Determining the beginning inventory:
Beginning inventory = (Ending inventory + COGS) – Amount of inventory purchased inventory
$4800 – $3000 = $1800
Don’t Have Time to Jog your Brains?
An Online Beginning Inventory Calculator May Come in Handy…
Who said mathematics and accounting always has to be so daunting? No one!
Calculating the beginning inventory of your business at the end of each accounting period can be time- and energy-consuming. This is especially true if you’re lacking a reliable system that can help you track all your inventory accurately.
Well, technology is here to sort you out. It’ll save your time and help you reduce the chances of making slight errors that tend to occur during the process of calculating your beginning inventory.
The online BI calculator takes a matter of seconds to give you accurate results. It doesn’t require a staff team to perform a physical count or inventory audit of the remaining products. Additionally, these calculators store your digits and will fulfill your orders.
If you’re looking for something that can perform better than the BI calculators, maybe you should think of an inventory management software.
Unlike the software, this one monitors the inventory levels in your firm (it also does so if you’re operating multiple warehouses). It is suitable for any business person who’s looking to grow his/her ecommerce businesses within the shortest time possible.
Also, such a software allows you to view all your historical inventory amounts. To do so, simply adjust the filters to a date that ranges your choice then filter the option down to the lot or product level. Lastly, view the displayed status using the channel you sold your products on, and more.
Having Multiple Warehouses?
Generally, large companies that ship high volumes of products across different regions opt to have a ‘distributed’ inventory structure. In this structure, inventory is subdivided then stored in different fulfillment centers. The division not only helps to save on the shipping costs but also speed up an order delivery.
Contrary to the common belief, business owners with multiple warehouses also need to calculate their beginning inventory.
Fortunately, multiple warehouses needn’t struggle to calculate their beginning inventory. The calculation method and steps are almost similar with that of small and medium-sized businesses with a slight variation in valuing the cost of goods.
Key Tips to Calculating Your BI
Failure to know the basic principles and requirements of calculating your BI makes you have wrong results and thus poor decision making. Thankfully, we’re here to help you not to err. With the below tips, you’ll get everything accurate:
- Knowing the things that should count as a purchase in the inventory context is paramount to having accurate beginning inventory calculations. Noteworthy, purchases include three main things: any equipment that was acquired during your manufacturing process, all the raw materials purchased for production, and the inventory of the finished goods purchased from your supplier(s).
- Monitoring the inventory balance of your business at the end of each accounting period is vital as it helps you know the demand of your customers and how to meet these demands. However, this doesn’t mean that you monitor your inventory balance too much until your hands are tied and you end up using the funds for other business operations.
- The BI explains whether you’ve sold more than you purchased or not. In the cases where the BI is more than the ending inventory, it is clear evidence that you’ve sold more than what you’ve bought during a specific period.
- Beginning inventory also tells you how much deadstock you may potentially have. It’s not a good thing to have a high amount of beginning inventory, if you’re dealing with perishable goods. It increases your risk of making losses further down the line. However, when you look at it, the concept is useful.
Truth be told, every business person desires a higher profit margin. You’re not an exception! That is why knowing how to calculate the beginning inventory is paramount. The BI forms the dollar value of the total stock that a business holds at the beginning of an accounting period.
Note this; calculating the beginning inventory involves the simplest and most straightforward formulae. But if you find this to be daunting, you can consider involving a professional inventory manager.
Inventory managers deal with long daily lists of inventory logs. They’re given the role of reporting different inventory metrics, especially the beginning inventory. Understanding the calculation enables your company to determine the goods it is put to put towards generating revenue.