Finished goods inventory is the total on-hand stock of products that have completed the production process and are ready for sale. The value of these products must be reported in your financial records. Without it, you can’t accurately measure profitability or liquidity.
During my career as an inventory manager, I saw what happens when finished goods inventory is not managed effectively: profit margins decline, customers are left unsatisfied, and productivity suffers.
In this guide, I’ll walk you through the most important things to know about finished goods inventory: what it is, how to calculate its value, and where finished goods inventory is reported in accounting.
What is finished goods inventory?
Finished goods inventory refers to all manufactured products currently in stock and available to be purchased by retailers, distributors, and consumers.
There are three main types of manufacturing inventory:
- Raw materials.
Product ingredients that have not yet been processed or assembled. - Work-in-process (WIP) inventory.
Partially completed products that are still in the production process. - Finished goods.
Completed products that are ready to be sold to customers.
The classification of finished goods inventory is relative to the business. Products that are categorized as finished goods by the manufacturer may later be classed as raw materials by a company that purchases them.
For example, a soda producer may class its bottled soda as finished goods inventory. But a pre-mixed cocktails manufacturer that uses that same soda as an ingredient may count it as raw materials inventory.
PRO TIP: It’s important not to misclassify finished goods inventory as this can skew the accuracy of inventory valuations.
Other examples of finished goods include:
Jewelry
Furniture
Smartphones
Clothing
Motorbikes
The status of finished goods inventory—including on-hand stock levels and storage locations—is tracked by an inventory manager or warehouse manager.
In accounting, the total value of a company’s finished goods inventory must be reported in the current assets section on the balance sheet for each period. Finished goods inventory value is usually tracked by a company’s finance team or a contracted accountant.
How raw materials become finished goods in the manufacturing process
When products are described as finished goods inventory, we can infer that they’ve completed the manufacturing process and are ‘waiting’ to be sold.
The process that takes inventory from raw materials to finished goods looks like this:
01
Raw materials are purchased from a supplier
02
Raw materials are assembled into work-in-process inventory (components)
03
Work-in-process inventory is assembled into finished goods (products)
04
Finished goods are sold to a consumer, retailer, or distributor
Depending on the type of product, there may be other steps involved—or less.
Some companies will bypass the work-in-process stage and build products directly from raw materials.
Others, including a quantum computer lab I worked for back in 2020, include multiple testing stages.
Finished goods inventory example
When I was an inventory manager at D-Wave, a Canadian electronics company, our manufacturing process comprised dozens of steps to ensure finished goods came out flawless.
Intensive audits, tests, and reworking occurred at every level—one mistake, one faulty component, could cost the company millions in lost revenue.
Here’s an overview of the manufacturing process at D-Wave Systems:
- Procurement.
Raw materials—nickel rods, sheets of silicon, filter systems—are purchased in bulk from various suppliers and added to our inventory system. - Components manufacturing.
Sub-assemblies are assembled onsite or purchased from a third-party manufacturer, including quantum computing chips, refrigeration systems, and air filters. - Quality control.
Components and raw materials are inspected by quality assurance testers. Any faulty or damaged items are returned (if purchased from a supplier) or recycled (if produced onsite). - Manufacturing.
Approved raw materials and components are assembled by quantum hardware engineers and interns to produce quantum computing systems. - Testing.
Computers are rigorously tested and monitored by a team of QA engineers. - Inventory management.
Once a computer has passed the final testing stage, it is recorded as finished goods inventory until it is sold.
There are smaller steps within this process I have excluded for brevity. With customers that included the likes of NASA and Volkswagen, D-Wave’s quantum computers represent an extreme case of the finished goods inventory process.
Using a different example, the process for a simple clothing brand might look like this:
- Procurement.
Plain clothing is purchased from a wholesaler or manufacturer. - Manufacturing.
The brand’s logo is printed onto the clothing, which is then affixed with a label and listed for sale. - Inventory management.
The product is sold and delivered to the customer.
The finished goods inventory formula
The finished goods inventory formula is:
Beginning Finished Goods + Cost of Goods Manufactured (COGM) – Cost of Goods Sold (COGS) = Finished Goods Inventory
This formula tells you the total value of your finished goods inventory. It’s important to know this value because it must be reported on the balance sheet as part of your financial reporting process.
The finished goods inventory formula is also valuable for understanding the liquidity of your business, and how much of your cash flow is tied up in unsold stock.
Finished goods inventory equation example
Let’s apply the finished goods inventory formula to a real-life scenario.
Say you start the period with a beginning finished goods value of $30,000.
At the end of the period, your COGM is $12,000 and your COGS is $9,000.
To work out your finished goods inventory value, you would calculate:
$30,000 + $12,000 – $9,000 = Finished Goods Inventory ($33,000)
Finished Goods Inventory Calculator
How to calculate finished goods inventory
To calculate finished goods inventory using the finished goods inventory formula, you must determine:
Beginning finished goods inventory
Cost of goods manufactured
Cost of goods sold
Without this information, you won’t be able to accurately determine the value of your finished goods inventory.
How to find beginning finished goods inventory
Beginning finished goods inventory is equal to the ending finished goods inventory from the previous period. As a formula, it looks like this:
Ending Finished Goods Inventory (of Previous Period) = Beginning Finished Goods Inventory
So, if your ending finished goods inventory value was $15,000 for the last period your beginning finished goods inventory for this period would be $15,000. If there is no previous period to reference, as in the case of a new business, your finished goods inventory will be zero.
How to find cost of goods manufactured
Cost of goods manufactured is the total cost incurred from manufacturing products and preparing them for sale during the current period.
The COGM formula is:
Cost of Goods Manufactured = Total Manufacturing Costs + Beginning Work-in-Process Inventory – Ending Work-in-Process Inventory
To break this down:
Total Manufacturing Costs = direct labor costs + direct materials costs + manufacturing overhead
Work-in-Process Inventory = the total value of partially completed goods still in production
Beginning Work-in-Process Inventory = ending work-in-process inventory from the previous period
Let’s say I start the period with five partially completed goods.
By assigning costs to these items based on the materials, labor, and overhead costs incurred to get this to this stage, I calculate that my work-in-process inventory value is $8,000.
At the end of the period, I repeat this process to determine my ending work-in-process inventory—which comes to $4,500.
My total manufacturing costs for the period are $50,000.
To determine my cost of goods manufactured, the calculation becomes:
$50,000 + $8,000 – $4,000 = COGM ($54,000)
Cost of Goods Manufactured Calculator
How to find cost of goods sold
Cost of goods sold refers to the cost of inventory that was sold during the period you want to measure.
The COGS formula is:
Cost of Goods Sold = Beginning Finished Goods Inventory + Cost of Goods Manufacturing – Ending Finished Goods Inventory
As an example, let’s say you begin the period with a finished goods inventory value of $44,000.
You end the period with a finished goods inventory value of $22,000.
Your total COGM for the period is $19,000.
The cost of goods sold calculation would look like this:
$44,000 + $19,000 – $22,000 = COGS ($41,000)
Cost of Goods Sold Calculator
Calculating these formulas in a logical sequential order
You might’ve noticed that there is something of a circular dependency with the finished goods inventory formulas above. You need to know finished goods inventory to calculate COGS, but you need to know COGS to calculate finished goods inventory.
So, how do we get around this?
Here’s a three-step solution for overcoming the circular dependency:
01
Start with any known and observable values by performing a physical count of your finished goods inventory at the beginning and end of the period.
02
Use production, sales, and purchasing data to calculate product costs.
03
Use the finished goods inventory formulas sequentially, based on the data you have available, to solve any unknown figures.
PRO TIP: It’s easiest to calculate COGS last. Finished goods can be determined by conducting a physical count and COGM can be determined by tallying up your total manufacturing costs.
How does understanding finished goods inventory help your business?
From an accounting perspective, calculating your finished goods inventory value helps you measure profitability and set competitive product prices. You need to know it because it must be reported on the company’s balance sheet, under current assets.
Finished goods inventory accounting helps you:
avoid overproduction
understand profitability and cash flow
understand your tax obligations
optimise product pricing
But that’s not all. Understanding finished goods inventory isn’t just good-practice accounting—it’s also good-practice inventory management.
Finished goods inventory management
Correctly managing finished goods inventory helps you make the right decisions regarding how your supply chain operations are managed. It helps you achieve high customer satisfaction rates, efficient inventory management, and cost-effective inventory purchasing.
Using spreadsheets or paper-based systems, known as the ‘traditional’ method, creates challenges for managing finished goods inventory.
Instead, use inventory management software or partner with a 3PL to:
track finished goods inventory
reduce wasted time and labor costs
satisfy demand for your products
minimize stockouts
ensure accurate on-hand inventory levels
Should you carry extra stock of finished goods inventory?
Holding stock of finished goods inventory means you’re able to shorten customer lead times (compared to made-to-order manufacturing services), but it’s not for everyone.
The risk of overstocking is greater when you maintain a supply of unsold finished goods. This means you’ll have less capital to work with and require more storage space for your inventory.
On the other hand, you’ll still have something to sell if there’s a problem with your supply chain. Customers won’t have to wait for an item to be made from scratch to get their hands on it.
While holding finished goods inventory can work well for companies selling lots of identical items, it’s not ideal for a completely bespoke operation.
For example, if you manufacture custom t-shirts and decide to pre-print 100 t-shirts with a photo of a puppy on them, you’re probably going to end up with 100 unsold puppy t-shirts and less available capital to pay for your other expenses.
Whereas if you sell plain black t-shirts and, based on forecasted demand levels, you expect to sell 100 black t-shirts next month then producing these before they’re sold may result in higher customer satisfaction rates and give you a competitive edge.
How Red Stag Fulfillment can help you manage finished goods inventory
As a manufacturer, managing finished goods inventory can be a time-consuming and expensive task. It’s another plate you have to keep spinning and comes with additional storage considerations, new hires, and a learning curve.
Partnering with a third-party fulfillment provider means you can keep focusing on making your products without worrying about how they’re managed.
At Red Stag Fulfillment, we leverage best-in-class warehousing systems and our dynamic team of inventory and order management experts to give manufacturers one less thing to worry about. Reach out today to learn more about how we can help.
