In business, the term ending finished goods inventory is often used. As the name implies, this is the stock of products that are ready for sale but not yet sold. A budget for these goods can be developed after calculating the basic costs of materials, direct labor costs and overhead budgets required to produce the products.
Why do we need this?
The ending finished goods inventory budget is very important for the company because it can provide a value for each unit produced based on raw materials, direct labor and overhead.
This information and data is used to complete the cost of goods sold budget. In fact, these two budgets are necessary to complete a balance sheet.
Not only that, this information is one of the factors required to determine the price of goods to be sold. In order to cover all costs and make profits, the company certainly needs to know how much money is needed to produce each item in a business’ inventory.
Its Role in the Operating Budget
Businesses of various scales require an operating budget as one of the two components of the master budget. This budget describes the company’s revenues and expenses, which include sales and the finished goods inventory. The other part of the master budget is the financial budget. It shows the inflows and outflows of cash and other elements of the company’s financial position.
The operating budget will be prepared first because information from the operating budget is needed to make a financial budget.
A Sample Budget
As an example, we can use consider a small business that produces pottery. The pottery business is a manufacturing business that uses two main materials: the clay and coloring for the clay.
For example, the cost of clay for each product is around IDR 10,000, and the cost of coloring for each product is IDR 5,000.
Total cost of direct materials per unit is IDR 15,000.
For example, every product takes about 2 hours to produce. The hourly rate for a worker is Rp 10,000.
Total direct labor cost per unit is IDR 20,000.
Every business has fixed overheads that may vary. The pottery business, for example, has a fixed overhead of IDR 30,000 per hour and a variable overhead of IDR 10,000 per hour. So, total is IDR 40,000 per hour. It takes 2 hours to produce each unit.
Total overhead cost per unit is IDR 40,000 x 2 hours = IDR 80,000.
Total three numbers add up to IDR 115,000 per unit. So, if you have 200 units of these finished inventories that have not been sold, your ending finished goods inventory budget would be IDR 23,000,000.
How Volume Impacts This Cost?
The numbers in the example above are impacted by volume. In terms of materials, raw material costs will be lower, by volume, the more that a business buys.
Direct labor is also impacted by volume. In many cases, workers can be more efficient, to a certain point, when producing a larger number of goods.
While it is then logical from a financial perspective to produce as many products as possible, a company also needs to consider realistic sales goals. Abundant inventory of finished goods will have no use, if not met by the market demand.
Any savings obtained by dealing a larger volume will not increase profits if production exceeds consumer demand or the ability of the sales staffs to sell the products.
How to Calculate Ending Finished Goods Inventory for a Manufacturing Company
Calculating the finished goods inventory for a manufacturing company requires the use of simple mathematical formulas. It requires the company’s inventory and production records to complete. In essence, your finished goods is the number of goods that you have at the beginning of the period, plus any added manufactured goods throughout the period, minus the manufacturing costs of any goods sold during that period.
The formula for calculating finished goods inventory is as follows:
Beginning Finished Goods Inventory + Cost of Goods Manufactured – Cost of Goods Sold.
Check Inventory Records
Check the company inventory records for the finished goods inventory for the previous period. Use this amount as your finished goods inventory for the beginning of the current period for the calculations. For example, if last year ended with IDR 100,000 in finished goods, then use this amount as your starting point.
Add Cost of Manufactured Goods
Now, add to your goods inventory the cost of good manufactured during the calculation period.
Make sure you include all costs, from material costs, direct labor costs to overhead costs.
The total will give you your total inventory value during that period. If you started with IDR 100,000 in inventory, added IDR 500,000 in new goods, then your total inventory for that period is IDR 600,000.
Subtract Cost of Goods Sold
Subtract the cost of goods sold during that period from your total inventory to calculate the finished goods inventory for a new period.
From the IDR 600,000 inventory, if you sold goods that cost you IDR 500,000 to produce during that period, then your finished goods inventory for the period is IDR 100,000.
Using the calculation
Calculating the finished goods inventory is an important process for calculating inventory ratios. In the end, this helps you understand the value of the goods in your inventory.
This helps to assess the valuation of a business for sales and as a consideration in projecting potential profits against the assumed sales of the finished goods.
In particular, a manufacturing company can use the finished goods inventory budget to calculate the rate of production for new units.
If the amount of finished goods inventory exceeds the rate of sales, the manufacturing company must slow down production. Conversely, if value of the finished goods is under serving the potential market, the production rate must increase.
The definition of finished goods inventory budget is the calculation of the costs of goods that have been completed and are ready to be marketed. However, these goods are still not sold and remain stored as reserves.
The finished goods inventory budget must always be updated and then recorded by the accounting team so the company can always determine the value of its finished goods inventory accurately.