How to Calculate Finished Goods Inventory & Why It's Important for Business

Managing your inventory can be one of the most challenging aspects of running a business. There are so many different things to track that it’s easy to get behind, mess up, or get overwhelmed. Your finished goods inventory is just one part of the puzzle when it comes to maintaining your inventory -- so you need to know how to calculate it! Read on to learn everything you need to know about this concept so that you can run your business like a pro. 

What Does Finished Goods Inventory Refer to?

Finished goods inventory refers to the number of products that are currently in-stock and are available for customers to purchase. This number is calculated using a simple formula and is a key component of inventory analysis. By keeping up with your finished goods inventory, you can effectively monitor your business, optimize your inventory, and calculate the overall value of the goods that you have available for sale. 

How to Calculate Finished Goods Inventory?

The good news is that you do not have to be a mathematician in order to calculate your finished goods inventory. The first thing that you need to do to calculate your finished goods inventory is to check your records and get all of your numbers for the actual equation.

The first number that you will need is the finished goods inventory for the previous period. The second number that you will need is the cost of goods that you have sold. The third number is the cost of all the goods that you have manufactured. From there, you should subtract the cost of goods sold (COGS) from the cost of goods manufactured (COGM). Then you should add that number to the inventory value of finished goods from the previous period. This leaves you with the value of your finished goods! 

It’s understandable if you’re not exactly an expert on finished goods inventory based on that explanation. After all, it can be difficult to explain mathematical equations with words rather than numbers. So let’s break it down even further and hopefully make it easier to understand by inputting some actual numbers and working with an example. 

Let’s say that you have a business that sells custom t-shirts -- “Custom T.” Each shirt costs you $5 to produce, and you had 100 t-shirts in stock at the end of last year. Your previous finished goods inventory value will be 100 x $5, which is $500. During the year, Custom T manufactured 300 t-shirts and sold 200 t-shirts. 

Therefore, the cost of goods manufactured (COGM) is 300 x $5, which is $1,500. And the cost of goods sold (COGS) is 200 x $5, which is $1,000. You subtract COGS from COGM, which is equivalent to $1,500 - $1,000 = $500. Finally, you add the previous finished goods inventory value of $500 to the previous solution of $500 to get a finished goods inventory worth $1,000. 

Why Finished Goods Inventory Is Important for Business?

Maintaining an accurate and up-to-date finished goods inventory value is a key part of running a successful and seamless business from start to finish. As a business owner, you know that knowledge is power, and you can easily use this data and knowledge to your advantage by being able to make necessary changes and optimizations based on your calculations. 

In fact, finished goods inventory is just one key performance indicator (KPI) that you need to maintain in order to effectively monitor your business. 

Other Things You Need to Know About Your Inventory

As mentioned above, KPIs are a necessary part of any successful business. That being said, this can be a confusing area to figure out for new business owners. Sometimes it seems like there’s a never-ending amount of data that you have to compile without even really knowing what it means or what to do with it. Thankfully, you don’t have to go it alone. 

Here are some of the most important KPIs that you should be tracking for your business:

• Inventory turnover ratio: This relates to the number of times inventory is sold and replaced within a time period. It is calculated by dividing your sales by your inventory during the period of a single year. Once you have this information, you can use it to your advantage to forecast future inventory issues, focus on underselling items to turn them over more quickly and improve inventory logistics as a result. 
  
  
• Average days to sell inventory: This relates to how long it takes a company to create inventory before actually turning it into a sale. It is calculated by dividing your inventory by cost of sales and then multiplying this number by 365. This number will then show you how long it takes you to sell each item of inventory. From there, you can tell which items you need to move more quickly as they are taking up space and costing you money. 
  
  
• Average inventory: This relates to the median value of your inventory over a defined time period. It is calculated by performing a simple average so that your data isn’t skewed by things like busy seasons and slow seasons. This number is able to show how fast inventory is selling and the average volume that you are keeping on-hand at any given time. 
  
  
• Inventory write-off: This relates to inventory that no longer has any value for the business, perhaps due to things like theft or damage. It is recommended to keep this number separate from others so as not to skew the rest of your calculations. Obviously, it’s a good idea to keep this number as low as possible. On the other hand, if this number is high, it’s definitely worth looking into to see if there’s a specific problem that is causing so much waste. From there, you can then take steps to eliminate this waste and make as much money as possible. 
  
  
• Holding costs: This relates to the costs that are incurred by packaging, storing, and maintaining your inventory. In an ideal world, your holding costs would be minimal, but unfortunately, that’s often not the case, which is why companies tend to focus on constantly moving inventory. 
  
  Depending on the weight and size of your products and the type of product packaging that you’re using, these costs can range quite a bit. Some specific examples of holding costs include renting the storage space, using storage equipment like forklifts, assembling your packaging, and paying storage workers.

How to Keep Up With All These KPIs?

Obviously, keeping up with all these numbers is easier said than done. If you’re a business owner, you definitely don’t want to spend all your time calculating these equations -- you have more important things to do. Your time as a business owner is very valuable, and you need to maximize your time by focusing on things like development, sales, building relationships, etc. -- not math equations. So what are you supposed to do?

Thankfully, technology can help you keep out with all these KPIs so that you don’t have to lift a finger! The right software can essentially do all the heavy lifting for you so long as you input a basic set of numbers. From there, it can calculate all of these KPIs and monitor them for you so that you can see what’s working and what’s not. If something isn’t working, you can be proactive and take steps to address them before it becomes too costly. 

When it comes to choosing an order management software, you should perform some research since this is actually a big investment for your business! You will want to look for a user-friendly platform that meshes well with the type of business you’re running. You will also want to look for a system that is flexible and allows you to customize different options, like minimum order quantity, backordering, or delivery exception, for example, as your business grows. Finally, you will want to look for a system that offers great customer service and undergoes consistent updates to ensure that it always functions at a high level. 

Final Thoughts

As you can see, being able to calculate your finished goods inventory value is an extremely important part of any business. The good news is that you don’t have to consistently calculate it on your own if you’re not exactly a math whiz. In fact, there are tons of different software options out there that can calculate this equation along with tons of others that will help you effectively and efficiently run your business. 

Sources:

1. The Age Of Analytics And The Importance Of Data Quality | Forbes
2. Identifying What to Watch: 14 Key Performance Indicators That Matter | Small Biztrends
3. The 5 Things You Should Really Be Focusing on If You Want a Successful Business | Entrepreneur