Beginning inventory is a complicated part of inventory management that many business owners don’t understand.
But it’s important to get right. By tracking beginning inventory, you can monitor inventory levels and better forecast what you need to order and when. That way, you can run a more effective and efficient operation.
Ahead, you’ll learn how to calculate and use beginning inventory in your store.
What is beginning inventory?
Beginning inventory is the value of your company’s inventory at the beginning of an accounting period. To calculate beginning inventory, you can use the following formula: (COGS + ending inventory) - inventory purchases.
Beginning inventory, also known as opening inventory, should equal the previous period’s ending inventory. If you’ve got $10,000 tied up in inventory at the end of a quarter, for example, you have the same amount in beginning inventory for the next quarter.
Beginning inventory formula
The simplest beginning inventory calculation uses this formula:
(COGS + ending inventory) - inventory purchases = beginning inventory
Let’s put that into practice and say you spent $5,000 manufacturing products throughout the year. You ended the previous accounting period with $10,000 ending inventory. From that $15,000, subtract the $6,000 you spent on inventory. Beginning inventory would be valued at $9,000.
How to calculate beginning inventory
To recap, here’s the formula for calculating the value of inventory at the start of an accounting period: (COGS + ending inventory) - inventory purchases = beginning inventory.
Let’s put the calculation into practice based on these figures:
- COGS: $50,000
- Ending inventory balance: $75,000
- Inventory purchases: $20,000
($50,000 + $75,000) - $20,000 = $105,000 beginning inventory valuation
Uses for beginning inventory
Beginning inventory has many uses beyond just accounting purposes. Below are a few of the different ways you can use beginning inventory:
- Identify shrinkage. Retail shrinkage happens when there’s a mismatch between your actual inventory and the numbers recorded during a cycle count. Often, the root of the issue is shoplifting or employee theft. Beginning inventory helps retailers spot phantom inventory before it becomes a major money drain.
- Accounting and bookkeeping. A balance sheet is one of the most important accounting records for any retail store. It’s a financial statement that shows your current assets and liabilities—including your inventory at the starting point of the period in question.
- Tax documents. Calculating your beginning inventory ahead of time, and making sure it isn’t too big or too small, can have tax-saving advantages. Inventory value also helps retailers calculate their tax liability in advance. If you know there’s a $15,000 tax bill coming up at the end of the tax year, you might want to adjust your open-to-buy budget accordingly.
How to find beginning inventory
The process for calculating beginning inventory relies on several other calculations. Let’s break down the other accounting formulas you’ll need to know.
Cost of goods sold
Cost of goods sold (COGS) shows how much money you’ve spent manufacturing products that have already been sold. This includes labor, shipping fees, production costs, and the price of raw materials.
Here’s the formula for calculating cost of goods sold:
COGS = (beginning inventory + purchases during period) - ending inventory
The cost of goods sold depends on the inventory method you’re using. We’ve outlined the four most common inventory systems below. Caution: Whichever you choose, you’ll need to stick with. Otherwise, you risk inconsistent data wreaking havoc with your financial reports.
- Weighted average cost. The average price of each SKU in your stockroom.
- First in, first out (FIFO). This method assumes that the products you purchased first were sold first, even if you bought them at different prices. If you sold four mugs during the previous period but bought 10 mugs at $5 and another 10 at $7, you’d use $5 to calculate the COGS.
- Last in, first out (LIFO). Unlike FIFO, this model assumes that the products you purchased last were sold first. In the example above, this would be $7.
- Gross profit method. The percentage of profit you’ll make after subtracting a product’s production and manufacturing costs. Use this free profit margin calculator to find yours.
Ending inventory is the dollar value of stock you have at the end of an accounting period. For this reason it’s sometimes referred to as closing inventory, and should match the beginning inventory for the accounting period that immediately follows.
The formula to calculate ending inventory is:
Beginning inventory + new purchases - cost of goods sold (COGS) = ending inventory
Inventory is the largest expense for any retailer. Understand how much you spend on inventory and use it to determine the value of your stock at the start of an accounting period by calculating inventory costs:
Inventory costs = purchase costs + ordering costs + holding costs + shortage costs
Why is beginning inventory important?
It’s clear beginning inventory plays an important role in accounting and business operations. Here are a few reasons why:
- Calculate COGS. You can’t calculate the cost of goods sold during a certain period without the beginning inventory figure.
- Understand business trends. It’s not just businesses that sell Christmas products that have seasonal sales cycles. Every retail business experiences seasonal shifts; certain products sell better than others at various points throughout the year. Beginning inventory helps you understand those trends and adjust your open-to-buy budget to prevent under- or overstocking.
- Improve financial analysis. Along with purchases and ending inventory, beginning inventory gives you a good idea of how a company manages its inventory.
- Better plan purchases. Beginning inventory helps you plan operations by giving you insight into your inventory levels. For example, if you start the period with a large inventory, you may plan fewer production runs or reduce purchasing.
- Better manage capital. Inventory is part of a company’s working capital, and effective inventory management helps with working capital management. From an inventory perspective, the beginning inventory figure gives you an idea of how much working capital you had at the start.
Retailers use beginning inventory to understand whether they’re holding too much inventory—or not enough—for the month, quarter, or year ahead.
Calculate your beginning inventory
Again, beginning inventory is a metric you’ll need to calculate at the start of any new accounting period. Use this formula to calculate yours, and rely on it to identify shrinkage, understand seasonal trends, and prepare for tax season.