Employees are often referred to as a business’s greatest asset — and rightly so.Butfew would dispute the importance of inventory (and its management) when it comes to acompany’s financial health. After all, how would anyone know how much product to orderor estimate potential profitability without knowing the quantity and value of what’salready on hand? Beginning inventory — the dollar value of inventory a company has atthestart of an accounting period — is a good place to start. Beginning inventory alsosets thestage for other significant financial calculations, including cost of goods sold (COGS) andinventory turnover rate.
What Is Beginning Inventory?
Beginning inventory is the total monetary value of items that are in stock and ready to useor sell at the start of an accounting period. Also called opening inventory, beginninginventory matches the previous accounting period’s ending inventory. Changes inbeginning inventory from one period to the next are subject to a variety of interpretations.A decrease, for example, could signal sales growth, or it could suggest a supply chain issue or a problem with inventory management.An increase may indicate a purposeful stocking up for a busy buying season, such as theholidays, or the opposite: a sales slowdown. Tracking beginning inventory can help abusiness identify market changes, forecast its inventory needs and inform its strategicdecision-making.
Key Takeaways
- Beginning inventory is the dollar value of a company’s inventory at the start ofan accounting period.
- Beginning inventory helps businesses understand sales trends that can lead to betterstrategic planning, budgeting and forecasting.
- Businesses value their beginning inventory using one of four different methods: FIFO,LIFO, weighted average cost or specific assigned value.
- Calculating the value of beginning inventory requires computing COGS, ending inventoryand inventory purchases for a specific period of time.
Beginning Inventory Explained
Companies report inventory as a current asset ontheir balance sheets. This helps paint a picture of their operations and potential revenueover the span of an accounting period, be it a month, quarter or year. Beginning inventoryincludes finished goods ready for sale, as well as the raw materials and components used toproduce those finished items and work in progress.
Ending inventory from one accounting period carries over as the beginning inventory for nextone, though only the former is listed on the balance sheet. Say a sneaker company usesmonthly accounting periods. On the last day of March, it has 1,000 pairs of unsold sneakersin inventory valued at $50,000. That represents its ending inventory for March and also itsbeginning inventory for April.
Why Is Beginning Inventory Important?
Beginning inventory can help a company uncover sales and operational trends, lead toimprovements in inventory management processes and, ultimately, boost profitability. Whetherit’s a small business with just one location or a large enterprise with worldwidelocations and warehouses, the accurate assessment of inventory can guide product pricing,whether items need to be replenished or written off, and budget allocation.
In addition, beginning inventory is an important component of inventory accounting for bothinternal and external purposes. (More on that soon.) It is also part of the formula todetermine cost of goods sold (COGS), which, inturn, helps predict a company’s profitability. And, of course, profitability, alongwith growth, is a key indicator of a company’s financial health and long-termprospects.
How and Where Do Businesses Use Beginning Inventory?
Like anything of value owned by a company, inventory is a business asset. Beginning inventoryhas an important role in accounting departments. There are three key areas of focus:
Balance sheets. A balance sheet summarizes all of a company’sassets and liabilities. A strong sheet can improve a company’s chances of qualifyingfor loans, as well as assure stakeholders that their investments are sound. Beginninginventory does not appear on the balance sheet, which typically reflects the end of anaccounting period, but it can be inferred because ending inventory is listed — and thenumbers should be the same.
Internal accounting. Taking stock of inventory at the start of eachaccounting period is useful for assessing future inventory needs, whether that means anincrease or decrease in production or in the amount to reorder. Companies also use beginninginventory data to seek out (and understand) possible differences from one period to thenext, as well as to protect against inventory shrinkage — loss generally attributed todamage, expiration, theft or bad math generated by manual calculations or subpar software.
Tax documentation. Imagine a warehouse is destroyed by a fire. Knowingbeforehand how much beginning inventory it had can help the company determine the value ofits loss for write-off and tax deduction purposes. But a catastrophic event isn’t theonly reason to record beginning inventory: Taxes, and possible deductions, are based on acompany’s COGS, which includes beginning inventory in its calculation.
How to Value Inventory
Beginning inventory is the financial value of inventory at the start of an accounting period.But the way inventory is valued for accounting purposes — and the subsequent impact onacompany’s financial statements — will vary by company and by what is being sold.Fourvaluation methods are typically used: first in, first out (FIFO), last in, first out(LIFO), weighted average cost and specific assigned value.
First in, first out: The FIFO valuation method — the most popular ofallfour methods — matches the “natural” flow of goods: It assumes thatinventory bought firstis sold or used first. Therefore, the cost of the earliest inventory sold first isrecognized when calculating COGS. FIFO typically results in a lower COGS and higher grossincome because inventory purchased earlier usually costs less than items purchased later on.
Last in, first out: Conversely, the LIFO method assumes the newest productsadded to inventory are sold or used first. Their costs are recognized first when calculatingCOGS, which would be higher — and gross income lower — than with the FIFOmethod. LIFO tendsto lower a company’s tax bill, thereby improving its cash flow.
Weighted average cost: This method averages the value of all inventory;it’s typically used when a company’s items are all the same. Calculatingweighted average cost is straightforward: Just add up the total cost of goods purchased inan accounting period and divide them by the total number of items. This method smooths outprice fluctuations that may occur when inventory is purchased over time.
Specific assigned value: This detailed valuation method — typicallyused formore expensive items, like vehicles — tracks individual pieces of inventory from thetime acompany purchases them until they are sold. Each item is priced individually as well, andclearly identified with a serial number or RFID tag. Specific assigned value is consideredthe most accurate determination of true inventory value.
Beginning Inventory Formulas, Ratios and Calculations
Although beginning inventory doesn’t appear on a company’s balance sheet or income statement, avariety of performance metrics do require beginning inventory for their calculation. Theyinclude:
Cost of goods sold (COGS): COGS, when subtracted from revenue, determines acompany’s gross profit. The lower the COGS, the higher the gross profit, and viceversa. COGS includes all of the direct, and mostly variable, costs needed to produceinventory for sale. The formula for COGS is:
COGS = (beginning inventory + purchases)–ending inventory
In practice, say a T-shirt company begins a quarter with $8,000 worth of inventory. Duringthe three months that follow, it sells $6,000 in T-shirts and makes $2,000 worth ofpurchases. At the end of the quarter, $4,000 worth of T-shirts remain ($8,000 beginning–$6,000 sold + $2,000 purchased).
Now we can determine COGS, where:
- Beginning inventory = $8,000
- Purchases = $2,000
- Ending inventory = $4,000
Therefore, COGS equals $6,000 ($8,000 + $2,000 – $4,000).
Inventory turnover: Inventory turnovermeasures how many times, on average, a company sells and replaces inventory in a given timeperiod. It’s a key indicator of how well a company manages its inventory and serves asa measure of its liquidity. However, the rate ofturnover typically depends on what is being sold. The T-shirt company, for example, willlikely have a much higher inventory turnover than, say, a luxury yacht manufacturer.
Calculating inventoryturnover relies on COGS and average inventory. The formula to calculate averageinventory for an accounting period is:
Average inventory = (beginning inventory +ending inventory) / 2
The inventory turnover ratio can now be calculated. The formula is:
Inventory turnover ratio = COGS / averageinventory
Using our T-shirt company above, average inventory is $6,000 ($8,000 + $4,000 / 2). Wealready determined COGS to be $6,000. Therefore, the company’s inventory turnover rateis 1 time during a quarter ($6,000 / $6,000).
Days in inventory (DII): Also called days sales of inventory, DII determinesthe number of days a company takes to convert inventory into sales. The lower the number,the more quickly a company is selling its inventory. The higher the number, the slower itssales. The formula to calculate DII is:
DII = (average inventory / COGS) x numberof days in that period
Back to our T-shirt company, which operates on a quarterly schedule. We know:
- Average inventory = $6,000
- COGS = $6,000
- Days in period = 90
Therefore, DII equals 90 days ($6,000 / $6,000 x 90).
How to Calculate Beginning Inventory
Beginning inventory for a new period is the same as ending inventory from the previousperiod. In the example above, our T-shirt company’s ending inventory for the quarterwas $4,000; therefore, its beginning inventory for the following quarter is also $4,000— nocalculation necessary. If the company wants to “roll backward” and double checkitsbeginning inventory figure for reconciliation auditing purposes, the formula is:
Beginning inventory = (COGS + endinginventory) – cost of inventory purchases
We know:
- COGS = $6,000
- Ending inventory = $4,000
- Purchases = $2,000
Therefore, beginning inventory equals $8,000 ([$6,000 + $4,000]) – $2,000), whichmatches thefigure in the previous section.
Demand forecasting: Historical inventory, seasonality and sales data canhelp a business predict demand for its products in the days, weeks and months ahead. Thisprocess of predicting future sales is called demand forecasting. For example, if a companysees a spike in sales of coffee mugs every April, a reasonable conclusion would be to boostinventory levels in March to meet the increase in demand and avoid stockouts.
Demand forecasting helps a company answer key questions about how much inventory is neededfor stock and fulfilling future orders, how often to replenish it and how sales trends maychange. It can also help estimate total future sales and revenue. On a more macro level,demand forecasting helps a company prepare its budget, plan and schedule production,determine storage needs and develop a product pricing strategy.
If a business is fairly new or a new product is being introduced — i.e., there’slittleto no past data to analyze — a more qualitative approach to forecasting may takeplace. Thiscan include market research, surveys and polls, comparative analysis and expert opinions.
A more sophisticated forecasting approach looks at specific variables affecting demand.Depending on the type of business, this causal model could factor in the competition,economic forces, weather, societal shifts and/or changes in marketing and advertisingstrategies and budgets, to name a few.
Monitor and Manage Inventory With Software
Inventory management is critical for any business that sells products. NetSuite InventoryManagement, provides a real-time view of inventory across all locations and saleschannels. NetSuite Inventory Management automates the tracking of inventory, orders andsales. It also features demand-based planning to help ensure that the right amount ofinventory is in stock at any given moment. Not buying enough can lead to stockouts, whereasbuying too much ties up cash and may result in write-offs and price discounts. In addition,NetSuite’s software tracks costs and inventory value, which are necessary forcalculating beginning and ending inventory, COGS, turnover and other items needed for properaccounting.
Conclusion
Beginning inventory embodies the phrase about not knowing where you’re going until youknow where you’ve been. The accurate calculation of inventory value at the start of anaccounting period will indicate how much revenue can be generated in the next period.Studying the sales trends of inventoried products over time helps companies forecast theirbudgets and best prepare for seasonality of certain inventory.
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Beginning Inventory FAQs
Why is beginning inventory useful?
Beginning inventory allows businesses to better recognize their sales and operational trends.Measuring and analyzing beginning inventory offers insight into the value of products onhand and can improve business strategy and efficiency. Such historical data gives businessesan opportunity to prepare and plan for seasonal or cyclical sales.
What is included in beginning inventory?
That depends on the type of business. A manufacturer’s beginning inventory may includeraw materials and individual components, as well as items in production and finished goods.A retailer’s beginning inventory includes all products available and ready to be soldto customers.
How do you calculate beginning and ending inventory?
The first step to calculating beginning inventory is to figure out the cost of goods sold(COGS). Next, add the value of the most recent ending inventory and then subtract the moneyspent on new inventory purchases. The formula is (COGS + ending inventory) –purchases.
Calculating ending inventory involves similar elements. Add the beginning inventory valuefrom the start of the period with purchases made during the period. Then subtract COGS. Theformula is (beginning inventory + purchase costs) – COGS.
How do you find beginning inventory cost?
The beginning inventory of one accounting period should match the ending inventory of theprevious period. To determine beginning inventory cost at the start of an accounting period,add together the previous period’s cost of goods sold with its ending inventory. Fromthat sum, subtract the amount of inventory purchased during that period. The resultingnumber is the beginning inventory cost for the next accounting period.
