What Ending Inventory Is and Why You Calculate It

Ending inventory is the value of goods your business still has on hand at the close of an accounting period — usually the end of a month, quarter, or year. You need this number to know how much profit you actually made, because the cost of goods you sold comes straight from what you started with plus what you bought, minus what you have left.

Without an ending inventory count, you cannot complete your income statement or balance sheet. The figure also tells you whether your records match what is physically in your warehouse or store, and it becomes your beginning inventory for the next period.

Key Takeaways

  • Ending inventory is calculated as: Beginning Inventory + Purchases − Cost of Goods Sold, or by counting physical stock and multiplying by unit cost.
  • The two main methods are periodic (count at period end) and perpetual (track every sale in real time), and your choice affects how often you do the math.
  • You must assign a cost to each unit using FIFO, LIFO, or weighted average, because identical items bought at different times may have different prices.
  • A physical count catches theft, damage, and record errors that formulas alone will not find.
  • The ending inventory number flows directly into your cost of goods sold calculation and your balance sheet asset total.

The Two Methods: Periodic and Perpetual Inventory Systems

A periodic inventory system means you count your stock only at the end of each accounting period. You do not track sales in real time. At period end, you physically count everything, assign costs to those units, and calculate ending inventory. This method is simpler for small businesses with few transactions, but it gives you no running total during the month.

A perpetual inventory system updates your inventory balance after every sale. Each time you sell a unit, the system records it and reduces your inventory count when ready. You still do a physical count at period end to catch errors, but you have a current balance throughout the period. Most modern point-of-sale systems and accounting software use perpetual tracking.

Both methods arrive at the same ending inventory number if done correctly. The difference is how often you know it and how much work you do in between.

The Formula: Beginning Inventory Plus Purchases Minus Cost of Goods Sold

The standard formula is:

Ending Inventory = Beginning Inventory + Purchases − Cost of Goods Sold

Beginning inventory is what you had on hand at the start of the period (which was the ending inventory from last period). Purchases is the total cost of all goods you bought during the period. Cost of goods sold is what those items cost you to acquire, not the price you charged customers.

Example: You start January with $5,000 in inventory. You buy $12,000 in new stock during the month. Your cost of goods sold for January is $10,500. Your ending inventory is $5,000 + $12,000 − $10,500 = $6,500.

This formula works only if your records are accurate. If you have theft, damage, or data entry errors, the formula will not catch them. That is why you also do a physical count.

Physical Count and Cost Assignment Methods

After you count the units physically, you must assign a cost to each one. If you bought identical items at different prices, which cost do you use? Three methods are standard: FIFO, LIFO, and weighted average.

FIFO (First In, First Out) assumes the oldest items sold first. Your ending inventory consists of the newest (most expensive, in inflationary times) purchases. FIFO gives you a higher ending inventory value when prices are rising.

LIFO (Last In, First Out) assumes the newest items sold first. Your ending inventory consists of the oldest (cheapest, in inflationary times) purchases. LIFO gives you a lower ending inventory value when prices are rising, which lowers your reported profit and your tax bill.

Weighted average calculates the average cost per unit across all purchases in the period, then applies that average to every unit in ending inventory. It smooths out price swings and is simpler to track than FIFO or LIFO.

Your choice of method affects your profit, your tax liability, and your balance sheet. Once you pick one, you must stick with it unless you have a good reason to change and you disclose the change in your financial statements.

Step-by-Step Calculation Example

Suppose you run a bookstore. On March 1, you have 200 copies of a novel on hand, each costing you $8. During March, you buy 500 more copies: 300 at $8 each and 200 at $9 each. You sell 600 copies during the month. What is your ending inventory on March 31?

Using FIFO: You sold the 200 original copies ($8 each) plus 300 of the new $8 copies and 100 of the $9 copies. You have left: 200 copies at $9 each = $1,800 ending inventory.

Using LIFO: You sold 200 copies at $9 each and 400 copies at $8 each. You have left: 200 copies at $8 each = $1,600 ending inventory.

Using weighted average: Total cost is (200 × $8) + (300 × $8) + (200 × $9) = $1,600 + $2,400 + $1,800 = $5,800. Total units are 700. Average cost per unit is $5,800 ÷ 700 = $8.29. You sold 600, so you have 100 left at $8.29 each = $829 ending inventory.

The method you choose changes your answer by hundreds of dollars, which is why it matters.

Physical Count Versus Formula: Finding Discrepancies

After you calculate ending inventory using the formula, count your stock physically. If the two numbers do not match, you have a discrepancy. The difference is called inventory shrinkage and usually comes from theft, damage, spoilage, or record errors.

If your formula says you should have $6,500 in inventory but you count only $6,200, you have $300 in shrinkage. You record this as a loss on your income statement and adjust your inventory balance down to match the physical count. Your financial statements must reflect what is actually there, not what the math says should be there.

A small shrinkage rate (under 2 percent for most retail) is normal. A large one signals a problem: check your receiving records, look for damaged goods, review your sales records for errors, and consider whether theft is occurring.

How Ending Inventory Flows Into Your Financial Statements

Your ending inventory number appears in two places. First, it goes into your cost of goods sold calculation on the income statement. Cost of goods sold equals beginning inventory plus purchases minus ending inventory. A higher ending inventory lowers your cost of goods sold and raises your profit.

Second, ending inventory appears on your balance sheet as a current asset under inventory. It is part of your total assets and affects your working capital and current ratio.

Because ending inventory affects both profit and asset value, getting it wrong distorts your entire financial picture. This is why auditors and tax authorities pay close attention to how you count and value it.

Frequently Asked Questions

What if I use a perpetual system but still want to do a physical count?

You should. Even with perpetual tracking, do a physical count at least once a year (often at year end for tax purposes). Compare the count to your system balance. If they differ, investigate why and adjust your records to match the physical count. This catches errors and fraud that the system missed.

Can I change from FIFO to LIFO or weighted average?

You can, but it requires approval and disclosure. Changing methods is treated as a change in accounting policy, and you must explain it in your financial statement notes. The IRS has rules about when you can switch, especially for tax purposes. Consult a tax professional before making the change.

What happens if I do not count inventory at the end of the period?

You can calculate ending inventory using the formula, but you will not know whether your records are accurate. You may be missing theft, damage, or data errors. Most businesses and all audited companies count at least once a year. If you are filing taxes or seeking a loan, lenders and the IRS expect to see evidence of a physical count.

Does ending inventory include goods I ordered but have not received yet?

No. Ending inventory includes only goods you own and have physically received. Goods in transit to you belong to the seller until they arrive at your location (unless the purchase terms say otherwise). Check your purchase orders and receiving records to make sure you are not counting goods that are still on the way.

How do I handle inventory that is damaged or obsolete?

Do not count it at full value. If goods are damaged but still saleable, reduce their value to what you can actually sell them for. If they are obsolete or unsaleable, write them off to zero. Record the loss on your income statement. Overstating the value of damaged or obsolete inventory inflates your assets and profit, which is why auditors scrutinize it closely.