How to Calculate Finished Goods Inventory & Why it’s Important for Business
June 22, 2020
Managing inventory is one of the most demanding parts of running an ecommerce business. With so many moving parts, it can be difficult to keep track of all the inventory available for customers, especially as you expand into multichannel inventory management.
If you have inventory split across multiple fulfillment centers, inventory tracking becomes even more complicated. You have to account for inventory that’s currently going through the manufacturing process, in transit, and what’s readily available for purchase. It’s not easy to stay on top of, but there are ways to make inventory management easier.
One ‘tool’ used by ecommerce businesses is the finished goods inventory formula. By knowing the amount of finished inventory on hand, your small business can accurately determine stock levels for improved inventory tracking.
What is finished goods inventory?
Finished goods inventory is the total stock available for customers to purchase that can be fulfilled. Using the finished goods inventory formula, sellers can calculate the value of their goods for sale.
‘Finished goods’ is a relative term, as a seller’s finished goods may become a buyer’s raw materials. For example, a textile factory may produce materials that can be used in clothing such as cotton or silk. While these may be the textile factory’s finished goods, they can sell them as raw materials to apparel retailers who will create them into new finished goods: clothing.
Why is the finished goods inventory formula so important?
With the finished goods inventory formula, you can accurately predict how much inventory is needed to prevent stockouts. Out-of-stock products and backorders cause customers to wait a long time for their purchase until an item is back in stock or cancel the order altogether. Learn how the finished goods inventory formula can help your business.
1. Identifies gross profit
Balance sheets, financial statements, income statements, and other financial documents have to account for current assets — inventory being your biggest one. Financial budgets and operating budgets for the current year and following year are determined by the profitability of your small business.
2. Records the number of current assets
Even one mistake in your inventory accounting process can lead to an IRS audit. With the finished goods formula, you can easily track work-in-process (WIP) inventory, raw materials, and unfinished goods to ensure your accounting is accurate.
3. Reduces waste of materials
Knowing the optimal inventory levels for your business can save you money in the long run. Instead of spending a lot of money on warehousing an excessive amount of raw materials and finished products, you can save by storing only what’s needed.
4. Optimizes inventory management processes
Supply chain optimizations can can always be made through automation or labor efficiency. By knowing the finished goods formula, you’ll be able to track direct labor costs and manufacturing costs to find opportunities to improve production processes and automation opportunities.
Finished goods inventory abbreviations cheat sheet
Warning! This article is abbreviation-heavy. Here are the terms we’ll use in our finished goods inventory formula:
- COGM: Cost of goods manufactured
- COGS: Cost of goods sold
- FG: Finished goods
- WIP: Work in process
How to calculate finished goods inventory in 3 steps (with formula)
Calculating your finished good inventory follows a simple formula that requires your cost of goods manufactured (COGM) and cost of goods sold (COGS).
First, we’ll go through how you obtain those two figures. Note: You will want the time period to be consistent throughout these formulas.
- COGM is calculated as: (Beginning WIP Inventory + Total Manufacturing Cost) – Ending WIP Inventory
- COGS is calculated as: (Beginning Inventory + Purchases During the Period) − Ending Inventory
Once you have your COGM and COGS, you can put the finished goods (FG) inventory formula to use:
FG is calculated as: (COGM – COGS) + Value of Previous Year’s Finished Goods
Below we’ll walk through how to calculate finished goods inventory in more depth.
Step 1: Check your inventory records for finished goods inventory from the previous year
You can view this information in your warehouse management system, inventory management software, or through your accountants. The previous year’s inventory records help sets a basis for the finished goods formula.
Step 2: Subtract the current cost of goods sold from the cost of goods manufactured
Finding the difference between COGM and COGS helps you know the value of your goods for the current year.
Step 3: Add the previously finished goods inventory value to the answer from Step 2
Once you add the previous year’s finished goods value to the COGM and COGS difference, you’ll know the value of inventory you currently have to work with. Once you have the finished goods inventory value, you can determine if more inventory needs to be ordered or if you have enough for the current time period.
How 3PLs help improve finished goods inventory management
Constantly calculating COGM, COGS, and finished goods inventory is a hassle. Many ecommerce businesses outsource fulfillment and inventory storage to 3PLs (or third-party logistics providers) to hand off some of the more time-consuming tasks.
3PLs not only provide professional order fulfillment services but make inventory auditing and management easier than ever because they do all the work for you. And a tech-enabled 3PL like ShipBob makes it easy to track inventory at any time from a simple, yet powerful dashboard.
1. Simple inventory audits
Tracking all of your inventory is feasible when you’re a startup business selling a few products and only fulfilling a couple hundred orders a month. Once you scale and have to manage a growing number of SKUs with manual tracking, it quickly leads to issues with inventory.
With ShipBob, we carefully track all incoming inventory we receive from your manufacturer(s), you can track your inventory 24/7, and you can access demand forecasting tools that make it easy to know which products are moving fast.
2. Automate reorder notifications to prevent stockouts
With ShipBob, you can set and receive automatic reorder point notifications when inventory falls below a specific threshold for each SKU. Once you receive the alert, you can replenish inventory with the right reorder quantity needed.
3. Run reports on inventory trends and forecasting
ShipBob’s analytics tool makes it easy to see how your inventory is performing (e.g, best-selling and slow-moving products) and makes inventory forecasting much more intuitive. You essentially get inventory analytics and distribution metrics that are typically only available for enterprises.
By understanding your finished goods inventory, you can improve ecommerce inventory management and prevent stockouts to keep your customers happy and your business profitable.