How to Value Your Inventory (2022)

Although many small business owners set up shop to make a full-time income, one in five say they aren’t confident in their accounting and finance knowledge. That could be one reason why 30% of small businesses fail within the first two years.

Prevent your retail store from joining that sad statistic by brushing up on your accounting knowledge, starting with one of the most important metrics: beginning inventory.

What is beginning inventory?

Beginning inventory is the value of your company’s inventory at the beginning of an accounting period. Retailers use it to understand whether they’re holding too much inventory—or not enough—for the month, quarter, or year ahead.

Also known as opening inventory, it 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. 

Uses for beginning inventory

• Understand business trends
• Identify shrinkage
• Accounting and bookkeeping
• Tax documents

Beginning inventory has many uses beyond just accounting purposes. Below are a few of the different ways you can use beginning inventory (including for bookkeeping reasons).

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.

A higher beginning inventory value than the month prior, for example, could mean that sales are slowing down. There’s more product in your stockroom than at the same point last month. 

A lower beginning inventory value than the month prior could signal issues with your supply chain, or that products are selling better than normal. If the latter is true, consider using that extra cash to keep momentum by investing in more stock.

Identify shrinkage

Inventory 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—two problems which cost retailers $61 billion each year.

Beginning inventory helps retailers spot phantom inventory before it becomes a major money drain. Compare it against physical inventory counts and investigate any discrepancies.

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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.

Retailers need to know their beginning inventory balances because it’s used to calculate their cost of goods sold (COGS) on the income statement. COGS is a math formula of: Beginning inventory + purchases for the period – ending inventory = COGS

Tax documents

Tax season is a stressful time for any retail business owner. But 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. 

Beginning inventory formula

The simplest way to calculate beginning inventory is using 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 find beginning inventory

• Cost of goods sold
• Ending inventory
• Inventory purchases

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 accounting 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

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 purchases

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

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.

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.