When you run a small business, the end of the fiscal year is a busy, busy time. There are books to balance, accounts to close, and to top it all off, stock needs to be counted. This exercise of calculating how much inventory remains unsold is known as a year-end inventory count. It’s a critical process that needs to be meticulously conducted.

If you want your business to enter the new accounting period with a fresh start, it’s vitally important to count your year-end inventory accurately.

Let’s take a closer look at this process and how you can apply it to your business.

Year-End Inventory Explained

Year-end inventory can be referred to by several names, like ending inventory, end-of-year inventory, or closing inventory. It is the total value of all the unsold goods in your possession at the end of the fiscal year. Year-end inventory is represented by a dollar value and is included in your business’ closing financial statements for the year as an asset.

Here’s a simple example to illustrate what year-end inventory could look like for a small business. Consider a furniture shop that starts the fiscal year with $10,000 worth of chairs. Over the course of the year, 80% of the stock is sold, totaling an inventory value of $8,000. The leftover chairs, worth $2,000, will represent year-end inventory.

Small business inventory management depends on year-end inventory counts for several important reasons. Here’s why:

• Accuracy: Year-end inventory counts help your business reach an accurate count. Physically counting all the products on your store’s shelves and stockroom ensures that the figures represented on your spreadsheets or in your inventory management software are accurate. You can always investigate further to identify the reasons if you notice any discrepancies. If your ending inventory value is higher than the actual value of goods you possess, it could be due to reasons ranging from simple clerical errors to more serious problems like inventory shrinkage or theft.
• Optimize Income: Comparing your business’ net income to your ending inventory value lets you identify ways to increase the former. Ideally, you want your net income for the year to be higher than your year-end inventory. This typically signals that your business is generating more profit from the products you’ve sold than the value of products still in inventory. If it’s the other way around, you can find ways to flip the situation by negotiating better prices with your suppliers or finding ways to reduce operational expenses. However, this doesn’t always apply to retail businesses, which often end the year with higher inventory levels due to stocking up for the holiday season.
• Business Expansion: If you wish to grow your business, then it’s essential that you get your inventory management in order. Accurately counting year-end inventory helps you compile accurate business reports and paint a fair picture of your business’s profitability. All of these insights are essential for expanding your business, particularly if you are looking to attract investors or qualify for a business loan.

How to Perform a Year-End Inventory Count: Three Common Methods

There are many ways to count year-end inventory, and we will look at the three most widely used ones. To begin with, there is a simple formula that allows you to calculate ending inventory:

(Beginning inventory + net purchases) – Cost of goods sold (COGS) = Ending inventory

While this formula gives you a starting point to calculate your ending inventory, you need to pair it with the right method for the best results. One thing that you have to keep in mind is that once you choose an ending inventory counting method, it’s preferable to stick with it. Switching methods from year to year is a recipe for confusion and inaccurate inventory counts. With that said, here are the three most common ways to count year-end inventory.
 

1. FIFO

One of the most popular methods used to calculate year-end inventory value is the First In, First Out (FIFO) method. In this method, accountants operate under the assumption that the inventory acquired earlier was sold first.

Let’s look at an example to see how the FIFO method works in practice.

Imagine a fast fashion store that starts the year with a beginning inventory worth $6,000. The store then introduces a new stock item and purchases 40 shirts valued at $20 each. That would mean the new inventory was purchased for $800. Since the shirts were selling well, the store had to buy 20 more units of this SKU in safety stock later in the year, but the price had gone up to $25. This time, the cost of acquiring the shirts was $500. In total, the store bought 60 shirts for a total of $1,300.

Now, if the store managed to sell 35 shirts during the year, then the COGS would be $700 since the first batch of 40 shirts was purchased for $20 apiece. Using the FIFO method, the year-end inventory value would be:

($6,000 + $1,300) – $700 = $6,600
 

2. LIFO

Another popular method that is considered the inverse of FIFO is the Last In, First Out method. Here, the accountants assume that the newly acquired stock is sold first. This can affect the year-end inventory value. Let’s use the same example from above.

In the LIFO method, the COGS for 35 shirts would be different. It would be $500 for the first 20 shirts sold since they were bought for $25 per shirt and $300 for the remaining 15 shirts, bought at $20 per shirt. With this approach, the COGS goes up by $100, and the ending inventory value comes down by a $100, as the calculation shows:

($6,000 + $1,300) – $800 = $6,500

Remember, LIFO and FIFO yield different results only when the price of goods fluctuates during an accounting period.
 

3. Weighted Average Cost

The third common approach to calculating ending inventory value splits the difference between the FIFO and LIFO methods. The weighted average cost method uses an average price for every unit in the inventory.

Let’s revisit the fast fashion store for one last example. The weighted average for the new shirts in the store’s inventory is measured by dividing total cost of purchase by number of units. In this case, that is $1,300 divided by 60. This gives an average of $21.66 per shirt. So, the COGS would be $21.66 multiplied by 35. The ending inventory calculation will look like this:

($6,000 + $1,300) – $758.33 = $6,541.67

As you can see, this method ends up with an average inventory value somewhere between what you would get with either the FIFO or LIFO methods.

Four Best Practices for Counting Year-End Inventory

While there’s no getting around the labor-intensive process of year-end inventory counts, there are some steps you can take as a business owner to ensure the process goes smoothly. Here are some best practices to keep in mind the next time your year-end inventory count is approaching.
 

1. Pre-Count Audits

A full inventory count to calculate the ending inventory value is conducted only once a year, but small business owners should also conduct audits and cycle counts throughout the year. These smaller inventory counting exercises will help with business asset tracking in real time, and simplify the final year-end inventory count.
 

2. Freeze Periods

While it may be annoying in the short-term, setting a freeze period the day just before a year-end inventory count helps minimize the chance of errors. There is no stock entering or leaving your store during the freeze period, and this ensures the integrity of your count is maintained.
 

3. Categorize and Classify

Having your inventory organized before your year-end inventory count begins will make the process much easier. Group items by product types, prices, size, or other characteristics. Also, remember to dispose of any obsolete inventory that can’t be sold in the next accounting period before beginning your count.
 

4. Implement Technology

Plenty of technology is available to simplify inventory management, including year-end inventory counts. Tools like barcode inventory systems, warehouse management software, and other automated solutions reduce your dependency on manual counts, leading to fewer clerical errors.

Frequently Asked Questions about Year-End Inventory

What is inventory value at year-end?

A business’ inventory value at the end of the fiscal year is the dollar value of all the unsold stock it still has in its possession. This is known as year-end inventory, and it is carried forward into the next accounting period as beginning inventory.
 

What is the formula for year-end inventory?

In order to calculate year-end inventory, you need to add the value of the beginning inventory to the cost of all purchases during the period, and then subtract the COGS from that sum. The formula is expressed as:

(Beginning inventory + net purchases) – Cost of goods sold (COGS) = Ending inventory

Why do companies do year-end inventory?

There are several reasons that companies perform year-end inventory counts. These include:

• Accurate understanding of inventory levels
• Inventory forecasting for the upcoming year
• Filing tax returns for the business
• Attracting investors to the business

Is it better to have more or less inventory at year end?

There is no fixed standard for how much year-end inventory a small business should be holding. In some industries, such as grocery retail, it’s always better to sell off most of the goods in stock and have as small an ending inventory as possible. That’s because grocery products are mostly perishable. However, other businesses, like art galleries, can hold onto their artworks for several accounting periods without worrying about their condition. In that case, it’s alright to have a high-value year-end inventory.

Then there are some businesses, like home electronics stores, that have durable products but will still want to sell a significant portion of their inventory, since industry trends and consumer preferences can change from year-to-year.