In this article, we explore the inventory purchases formula in detail and how you can apply it. We will also walk you through our simple 6-step framework to illustrate how it works along with a real-world example. Read on to learn more.
The inventory purchases formula is used to determine the amount of inventory a business has purchased within a given period. To find the total inventory purchases, simply add the cost of items sold to the difference between the ending and beginning inventory levels.
Essentially, the basic formula is:
Inventory Purchases = Cost of Goods Sold + (Ending Inventory - Beginning Inventory)
The inventory purchases formula has four basic components, which we outline and explain below:
This is the value of products that a business has on hand at the start of a given period. Its accurate assessment is crucial as it sets the baseline for inventory movement during the period.
This encompasses all acquisitions of inventory during the time frame, whether made through cash or credit. The nature of these purchases, their timing, and their volume can have significant impacts on a business's inventory levels and financial health.
This denotes the value of products remaining unsold at the end of the period. A crucial metric, it gives insights into how effectively inventory has been managed and is used as a starting point for the subsequent period.
Representing the direct costs of producing goods that have been sold, COGS is intertwined with inventory levels. The higher the COGS, the more inventory has been converted into sales, impacting the volume of purchases.
Bella's Bookstore is a local bookseller. At the beginning of January, Bella's Bookstore had an inventory valued at $5,000. By the end of January, the ending inventory was $7,000. During that month, Bella's Bookstore reported a Cost of Goods Sold (COGS) of $8,000, which represents the cost of all the books sold during that period.
To find out how much inventory Bella's Bookstore purchased in January:
Calculate the difference between the ending and beginning inventory:
Difference = $7,000 (Ending Inventory) - $5,000 (Beginning Inventory) = $2,000
Add the difference to the COGS:
Purchases = $8,000 (COGS) + $2,000 (Difference) = $10,000
So, Bella's Bookstore purchased inventory worth $10,000 in January.
Auto Elite Dealership is a car dealer specializing in luxury vehicles. At the onset of April, Auto Elite had vehicles worth $2 million on their lot. By the end of April, the total value of cars on the lot decreased to $1.8 million. Throughout the month, Auto Elite recorded a Cost of Goods Sold (COGS) of $1.5 million from the sales of their vehicles.
To ascertain how much inventory Auto Elite acquired in April:
Calculate the difference between the ending and beginning inventory:
Difference = $1.8 million (Ending Inventory) - $2 million (Beginning Inventory) = -$200,000.
Add this difference to the COGS:
Purchases = $1.5 million (COGS) - $200,000 (Difference) = $1.3 million.
Thus, Auto Elite Dealership acquired vehicles worth $1.3 million in April.
Calculating inventory purchases using the formula is crucial for many reasons. Here are some key reasons why:
Cash Flow Management: It helps businesses plan and manage their cash flow by understanding how much is spent on inventory, ensuring they don't overextend financially.
Inventory Turnover Insights: The formula provides insights into the inventory turnover rate, which is vital for assessing how efficiently a company is selling its stock. A higher turnover indicates good sales performance, while a lower one may suggest overstocking or underperformance.
Financial Reporting Accuracy: For businesses that use accrual accounting, understanding inventory purchases is essential for accurate financial reporting, as inventory represents a significant current asset on the balance sheet.
Strategic Purchasing Decisions: By knowing how much inventory was purchased in a prior period, businesses can make informed decisions about future purchasing, capitalizing on volume discounts, or avoiding overstock.
Demand Forecasting: Regularly calculating inventory purchases helps businesses identify patterns and trends in demand, enabling more accurate forecasting and better stock management.
Minimize Holding Costs: Understanding purchase patterns helps businesses optimize inventory levels, thereby reducing associated storage, insurance, and potential obsolescence costs.
We hope this article has given you a better understanding of the inventory purchases formula and how you can use it to make better decisions for your business.
If you enjoyed this article, you might also like our article on total cost of inventory formula or our article on inventory availability.
