What Is Inventory Cost and How to Calculate It

Accurate inventory cost calculation is crucial for preparing financial statements, like your balance sheet and income statement. Since inventory represents a significant asset for many businesses, its valuation directly affects financial ratios, profitability analysis, and the overall financial health of your company.

We’ve provided a calculator and step-by-step guide to determine your inventory costs.

What is Inventory Cost?

Inventory costs are the expenses incurred when acquiring, storing, and maintaining a company's inventory. It encompasses various elements that contribute to the overall cost of managing inventory within a business. 

An accurate understanding of inventory costs is crucial for effective financial management and decision-making. Without regularly maintaining these costs, it can negatively impact your company’s profitability and cash flow. 

Inventory costs are typically split into 4 sections:

• Purchase Costs: Expenses incurred when acquiring inventory from suppliers or manufacturers. This includes the actual cost of purchasing the goods. 

• Holding Costs: Expenses associated with storing and maintaining inventory over time. These include warehousing or storage costs, insurance premiums, property taxes, utilities, and security.

• Ordering Costs: Expenses incurred each time inventory is ordered or restocked. Costs include activities such as placing orders, communicating with suppliers, and processing paperwork. 

• Shortage Costs: Expenses incurred when demand for inventory exceeds the available supply. These costs can include lost sales opportunities, customer dissatisfaction, rush orders or expedited shipping fees to replenish inventory.

QuickBooks Inventory Cost Calculator

Here’s our straightforward inventory cost calculator:

Inventory Cost Calculation Formula

There are multiple formulas involved with determining your inventory costs, depending on the costing method you use. These include: 

First-In, First-Out (FIFO) Method:

• Inventory Cost = (Quantity of Goods Sold x Cost of Oldest Purchased Inventory) + (Quantity of Ending Inventory x Cost of Most Recent Purchased Inventory)

Last-In, First-Out (LIFO) Method:

• Inventory Cost = (Quantity of Goods Sold x Cost of Most Recent Purchased Inventory) + (Quantity of Ending Inventory x Cost of Oldest Purchased Inventory)

Average Cost Method:

• Inventory Cost = (Quantity of Goods Sold x Weighted Average Cost per Unit) + (Quantity of Ending Inventory x Weighted Average Cost per Unit)

To calculate the weighted average cost per unit for the average cost method, you can use the following formula:

Weighted Average Cost per Unit = (Total Cost of Goods Available for Sale) / (Total Quantity of Goods Available for Sale)

How to Calculate Inventory Cost Manually 

To calculate inventory cost manually, you need to consider the cost of the goods purchased, any additional costs from acquiring and storing the inventory, and any adjustments for changes in inventory value. Here's a step-by-step guide on calculating inventory cost manually:

1. There are different methods for valuing inventory, such as first-in, first-out (FIFO), last-in, first-out (LIFO), and average cost. Ensure that you are aware of the costing method used by your business.
2. Add up the total cost of the goods purchased during the accounting period. This includes the purchase price of the items, any shipping costs, import duties, and other directly attributable expenses. This calculation provides the total cost of the inventory available for sale.
3. If you have inventory from the previous accounting period, determine its value and add it to the cost of goods purchased. You typically base the beginning inventory on the closing inventory value from the previous period.
4. Determine the inventory value that remains unsold at the end of the accounting period. This is known as the ending inventory. You can determine the value of the ending inventory using the same costing method as used for the cost of goods purchased.
5. Subtract the value of the ending inventory (Step 4) from the total cost of goods available for sale (Step 2 plus Step 3). This will give you the cost of goods sold (COGS) during the accounting period.
6. Finally, subtract the COGS (Step 5) from the total cost of goods available for sale (Step 2 plus Step 3). The resulting value represents the remaining cost of inventory that has not been sold.

If you use the FIFO or LIFO method, you must allocate the costs based on the order in which the goods were purchased or sold. Additionally, adjustments may be necessary for inventory write-downs, obsolescence, or any other changes in the value of the inventory.

How QuickBooks Can Help

Calculating inventory costs is essential for businesses that hold physical stock. If you hold stock, calculating your inventory costs allows you to practice careful financial management and make decisions about purchasing, production, and sales. 

QuickBooks inventory management software allows businesses to set up and manage their inventory by tracking the quantities and values of their products. You can record purchase orders, sales orders, and invoices, enabling your business to track the flow of inventory and its associated costs.

QuickBooks also automatically calculates the COGS based on the inventory values and quantities. By accurately calculating COGS, businesses can determine their profitability and make informed pricing decisions.

If you use different inventory valuation methods like FIFO and LIFO, QuickBooks can support you. Our software determines the cost of inventory sold based on the order in which items were purchased or added to the inventory. QuickBooks then automatically applies the chosen valuation method to calculate the cost of inventory and COGS.

Ready to automate your inventory cost calculations? Sign up for QuickBooks Online today.