Finished Goods Inventory: Definition & How to Calculate

What is finished goods inventory?

Finished goods inventory are items that have already been created or assembled and are ready to be sold.

Examples include:

Clothing finished goods – Shirts, pants, and socks
Electronics finished goods – Smartphones, computers, and tablets
Furniture finished goods – Chairs, tables, and beds
Food and beverage finished goods – Canned soda, frozen pizza, a carton of milk

Tracking finished goods inventory helps you maintain optimal and accurate stock levels while reducing the risk of stockouts or overproduction.

Additionally, your finished goods inventory value must be reported on the balance sheet. This value also helps you accurately calculate other crucial figures, including cost of goods sold (COGS) and cost of goods manufactured (COGM).

How to calculate finished goods inventory

There are two ways you can calculate finished goods inventory.

The first is to perform a manual count of your available finished goods and tally up the total value. For businesses in their first year of doing business, this can often be the only option.

The second approach is to use the finished goods inventory formula.

Before you can use the finished goods inventory, you'll need the following data:

Beginning finished goods inventory: The value of the finished products your business has at the start of a given period. You'll use this as a starting point for tracking changes in inventory levels over time.
Cost of goods manufactured (COGM): The total cost of producing products during the period, including materials, labor, and overhead. This will help you determine how much new inventory was created.
Cost of goods sold (COGS): The total cost of the inventory that was sold during a given period. Tracking COGS helps you account for products that have already left inventory and been sold.

Finished goods inventory formula

The finished goods inventory formula is an equation that helps you measure your current or ending finished goods inventory value. If you know your beginning finished goods inventory value, COGS, and COGM, this formula is helpful for financial reporting and measuring profitability.

The formula for calculating finished goods inventory:

Beginning Finished Goods Inventory + Cost of Goods Manufactured − Cost of Goods Sold = Finished Goods Inventory

Let’s look at some examples of how this formula can be applied in real life.

Example 1: A small clothing manufacturer

Let's say a small clothing manufacturer starts with $20,000 worth of finished inventory at the beginning of the month. During one month, they produce additional apparel worth $50,000 (COGM), and they sell $45,000 worth of goods (COGS).

In this example, the finished goods inventory formula looks like:

20,000 + 50,000 − 45,000 = 25,000

The company is left with $25,000 worth of finished goods inventory.

Example 2: A large electronics company

A large electronics company has $2,000,000 worth of finished smartphones in inventory at the beginning of the quarter. During the quarter, they produce additional smartphones valued at $8,000,000 (COGM) and sell devices worth $7,500,000 (COGS).

In this case, the finished goods formula would be:

2,000,000 + 8,000,000 − 7,500,000 = 2,500,000

The company has $2,500,000 worth of finished goods inventory.

Where is finished goods inventory reported in accounting?

In accounting, finished goods inventory represents the value of products that are ready to be sold. It is reported on the balance sheet under current assets.

Inventory is considered a current asset because the company expects to sell the goods and convert them to cash within a year or the normal operating cycle. This balance sheet later becomes part of the COGS on the income statement.

Here's a breakdown of how finished goods inventory works in accounting:

The associated costs are added as the products are manufactured. This includes spending on raw materials, worker wages, and manufacturing overhead. These accumulated costs initially are part of a work-in-progress (WIP) inventory during production.
Work-in-process goods are reported. Once products are ready, they're moved from the WIP inventory to the finished goods inventory account in a company’s accounting system. At this stage, the total production cost of each finished item is transferred.
Finished goods inventory calculation. Finally, the value of finished goods inventory is calculated depending on the company’s accounting policy. This ensures you'll be accurately tracking and reporting the cost of goods.

When you sell your finished goods, remove their cost from the finished goods inventory account. Then move them over to the COGS on the income statement.

How inventory becomes finished goods

Let's take a deeper dive into how inventory becomes finished goods and how you can make sure your business is fully prepared for sale every step of the way.

1. Raw materials procurement

The process begins with the acquisition of raw materials.

Materials are sourced and purchased from suppliers. When they arrive, the raw materials are recorded in the company’s inventory system and stored so they're available for production.

2. The work-in-progress stage

Once raw materials are sent to the production floor, they enter the work-in-progress stage and are transformed depending on the type of product being manufactured.

At this point, raw materials are combined with direct employee labor and manufacturing overhead. WIP inventory captures goods that are partially complete but not yet ready for sale.

Other steps in this process include:

Production scheduling
Cost tracking
Process optimization
Inventory control

In the case of a car manufacturing plant, raw materials like steel are shaped into car bodies, and other components such as engines and electronics, are integrated during the WIP process.

3. Finishing the product

When the production process is complete, WIP inventory is transferred to the finished goods inventory. At this stage, all manufacturing steps are closed. The products are fully assembled and are now for sale.

For example, in furniture production, the cut and shaped wood is polished, upholstered, or painted, and final adjustments are made to ensure the product is ready for the consumer.

4. Setting up a finished goods inventory and handling distribution

Once products have passed assembly and inspection, they are classified as finished goods, meaning they are now complete and ready to be sold or distributed to customers.

The finished goods are then stored in warehouses or distribution centers, waiting to be delivered to retailers, wholesalers, or directly to end consumers. Not properly managing this inventory? You won't be able to meet customer demand and can bump into problems like overstock or stockouts.

As an example at this stage, a food processing company producing canned goods stores its finished products in a temperature-controlled warehouse after labeling and inspection. They use inventory control systems to track expiration dates and ensure products are rotated to prevent spoilage.

Managing finished goods inventory

Effective finished goods inventory management helps your business meet customer demand, reduce storage costs, and direct supply chain efforts without too many hurdles. When poorly managed, finished goods will add problems such as stockouts, overstocking, higher carrying costs, and reduced profitability.

Here are some effective methods for managing finished goods inventory:

1. Set up demand forecasting

Accurate demand forecasting helps ensure you have optimal inventory levels. To predict future demand and adjust production schedules, use historical sales data, market trends, and advanced analytics. At this point, you also anticipate peak seasons or holiday sales times to decide when you need to increase production to meet customer needs without risking overstocking.

2. Adopt just-in-time (JIT) inventory

A just-in-time inventory system is what you need to avoid ending up with excess stock and reduce carrying costs. With JIT in practice, you'll produce only what you need when consumers demand it (i.e. when a customer makes an order, when a trend is set to rise).

3. Improve how you organize your warehouse

The older stock should always be sold first. Product bundling is a good alternative for slower-moving items. And you simply must have dedicated areas for clearance or discounted items as well as seasonal, time-sensitive products.

Use barcode scanning or radio-frequency identification (RFID) tagging to allow your staff to easily record and track stock levels and locations.

4. Work better with the people you have

Invest in staff training to ensure all employees are performing their roles effectively and efficiently. Another best practice is running regular audits of inventory to ensure accuracy. Instruct your team to make timely stock adjustments that can prevent potential issues from escalating.

You shouldn't neglect your suppliers either. Nurture your relationship with them as they're the ones that can help reduce lead times and enhance your supply chain efficiency.

5. Implement cloud-based inventory management software

Cloud-based inventory management software like Unleashed help improve stock accuracy and automate your finished goods inventory processes.

Your company might experience a surge in demand during holidays. It's common. By using an automated inventory system, you can ensure they have sufficient stock and manage production schedules effectively. Smaller businesses can also cut down on costs this way by not having to hire for such short high-demand periods.

Here are some of the key features of manufacturing inventory management software: