What is finished goods inventory and how to calculate it?

By Nguyen Oanh
Published: 10/25/21
how-to backgroundWhat is finished goods inventory and how to calculate it?

Finished goods inventory management is an essential part of the eCommerce business. It allows you to know what a business owns, the value of the products or goods it owns, and to reduce waste.

The inventory of the stock must be carried out with care and precision because the tax administration has the possibility of contesting it since it has an impact on the result of a company and therefore on the amount of taxes that it must pay.

In this article, we will explain what is finished goods, how it is important, and especially how to calculate finished goods inventory by giving you not only the formula but also some examples.

What is finished goods inventory?

Finished goods inventory is the number of inventory or manufactured items that are still available in the stock and that customers can still purchase.

A finished good is an item manufactured or modified by a company from raw materials. There is therefore a change in the condition of the product over time. The term finished product is generally found in businesses in a craft / industrial environment. For example, a clothing company buys textiles to create pants. Here, the pants are finished goods.

The “finished good” that we talk about can be the seller’s finished goods but also the buyer’s raw materials. For example, a textile factory creates silk and sells it to retailers who use them to create clothes.

Why is finished goods inventory important?

By calculating the finished goods inventory, you can know how much inventory is needed for the production process and stockout. It also helps you to avoid the situation when the clients wait too long for the restock of the product that they want and cancel their purchase.

Here are the reasons why finished goods inventory is important:

  • Strengthen your pricing strategies: A regular inventory of stocks will help highlight the state of your finances. It will allow you to analyze your sales, profits, losses, unsold items… and review your pricing strategies to maximize your profits.

  • Ensure the correct accounting process: The inventory makes it possible to identify any differences between the theoretical quantities (as they are calculated by the computer software, taking into account the inputs and outputs) and the actual quantities (as they were identified by the account teams). The reasons that may explain such deviations are loss, theft, damage, errors in the quantities delivered or shipped. By calculating the finished goods inventory, you can track all the information such as the amount of raw materials, the work in progress (WIP) process,…
  • Reduce the waste: Knowing the amount of raw materials used and the stock of finished goods helps you save a lot of money in the long term, instead of wasting a lot of money on producing supernumerary products.

  • Positively affected the whole production efficiency, logistic, and inventory process: By knowing finished goods inventory, you can track manufacturing cost and preview the cost of logistics and production and preview the amount of product needed.

  • Maximize ordering processes: The inventory will highlight stockouts, a classic case on the shelves but which is harmful to sales and the company's brand image. It is, therefore, necessary to have good long-term visibility to anticipate any delay in delivery or any damaged delivery.

How to calculate finished goods inventory?

Formula

The finished goods inventory is determined by 3 values:

  • Cost of goods manufactured (COGM)
  • Cost of goods sold (COGS)
  • Previously finished goods inventory value

To calculate the COGM:

COGM = (Raw materials + direct labor + manufacturing cost + beginning Work in process) - ending Work in process

To calculate the COGS:

COGS = Beginning inventory + purchasing cost - ending inventory

To calculate finished goods inventory:

Finished goods inventory = (COGM - COGS) + beginning Finished Goods Inventory value

Examples

To help you understand more and apply this formula, we take an example of a textile company X producing silk. At the end of 2020, factory X had 1000 finished pieces of silk in stock that needed to be sold. 1 piece of silk cost $5 each to fabricate. In 2020, factory X manufactured 1600 pieces and sold 900 pieces.

Previous finished goods inventory value = 1000 x $5 = $5000

Cost of goods manufactured = 1600 x $5 = $8000

Cost of goods sold = 900 x $5 = $4500

$8000 - $4500 = $3500

Finished goods inventory of factory X = $5000 + $3500 = $8500

FAQ about finished goods inventory

Are finished goods considered inventory?

Not really. Why?

  • The inventory is the act by which we identify all the movable and immovable property of an individual, a trade, or a company. It consists in counting the possessions of a company, for example, its stock, or its fixed assets.
  • Finished goods are one of 13 types of inventory and are the final product ready to sell to the client.

What are 4 types of inventory?

There are 4 types of inventory:

  • Raw materials: all the initial products used in the production or manufacture of finished or manufactured products. These are materials produced by nature that require processing for use. The definition of raw materials includes both the materials used to manufacture these finished products and the energy commodities required for their production.

  • Work in progress (WIP): The WIP is a semi-finished product for which an investment has been currently made. It is not yet salable because it does not correspond to the product that the customer potentially wishes to buy.

  • Finished goods: a product which, after a current transformation, manufacture, or construction, is ready for distribution and to be sold to the client.

  • MRO inventory: MRO stands for maintenance, repair, and operation inventory: It’s all the materials or supplies that will be used in the production and manufacturing process to fabricate a finished product.

How to calculate ending inventory?

Ending inventory is the value of the “leftover” inventory that still can be sold at the end of the accounting period. To calculate the ending inventory, we take the total of beginning inventory and net purchases and finish by subtracting the cost of goods sold.

You can use the following formula:

Ending Inventory = Beginning inventory + Net purchases – Cost of goods sold

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