Finished Goods Inventory

Updated on May 6, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What is the Finished Goods Inventory?

A finished goods inventory is the final stage of inventories where the goods have already passed through the manufacturing process. It includes all the goods that have attained their final form and are completely eligible to be sold to the end customers.

Finished Goods Inventory

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This is the stage where sellers conveniently calculate the cost at which they should sell the manufactured product. The carrying cost of these goods is inclusive of all freight charges and taxes. In short, by the time the goods become finished products and reach this final inventory state, sellers know the quantity, quality, and pricing of the products.

Key Takeaways

  1. Finished goods inventories are the last stage of inventories after the manufacturing process is complete. They include the goods that have reached their final form and are fully qualified for sale to the end customers.
  2. Finished goods inventories encourage a company to use tactics that contribute to raising demand for its products and services. As a result, sales increase, and finished goods are cleared from stocks faster as demand increases.
  3. Reduced levels of finished product inventories as a percentage of sales can be attributed to increased sales, better tools, and technologies, improved general business circumstances, etc.
  4. Inventory levels may benefit from technologies for the demand-driven supply chain management. It ensures that the shipment is always delivered on schedule and helps manage and cut down on supply days.

Finished Goods Inventory Explained

Finished goods inventory specifies the number of products that have successfully been through the manufacturing process, and has attained the final stage where sellers can sell them to customers. When a business manufactures a product, the carrying cost comprises direct labor, direct materials factory overhead costs. On the other hand, if the goods are the acquired ones, the carrying cost, as stated above, includes miscellaneous charges, including taxes, and freight charges.

While the sale of the goods is considered one of the major sources of revenue for a business, these are considered short-term assets, given the estimated time taken for these goods to be sold is approximately a year. The volume of these inventories, however, keeps fluctuating based on various factors.

The major reasons that negatively affect the levels of the finished goods are sales growth, implementation of better tools and technology, improved overall business conditions, etc. This, in turn, leads to a significant reduction in the percentage of sales. On the other hand, demand-driven supply chain management tools might have a positive impact on inventory levels. It helps manage and reduce supply days and ensures the shipment is always on time.

Make-To-Stock (MTS) and Make-To-Order (MTO) are two different strategies that help manage the finished goods inventory levels at manufacturing sites.

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Formula

It can be easily calculated with the help of details like the cost of goods manufactured, the cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more, and opening inventory. The expression that depicts how to calculate finished goods inventory is as follows:

Finished Goods Inventory Formula = Opening Finished Goods Inventory + Cost of Goods Manufactured – Cost of Goods Sold
Finished Goods Inventory Formula

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Calculation Example

Let us consider the following finished goods inventory example to understand its step-wise calculation.

ABC Ltd. manufactures diaries. Calculate the Finished Goods inventory from the details provided below-

  • Diaries manufactured- 500
  • Diaries sold – 200
  • Opening finished goods – 300
  • Cost of each diary – $10

To find the finished goods inventory, however, let us follow the solution given below:

Solution

Calculation of Finished Goods Inventory

Finished Goods Inventory Example 1
  • = $3,000 + $5,000 – $2,000
  • = $6,000

Thus the value of Finished Goods = $6,000

Advantages

The various advantages are as follows:

  • Enhancement in Sales – Managing it allows an organization to boost its sales and earn better profits. A company can easily accomplish its predetermined goals and objectives with better sales and profits figures.
  • Increased Focus on Inventories – Finished goods lying in inventories for a long time can impact an organization. Therefore, when an organization emphasizes more focus on inventories and takes initiative to clear off the finished goods as soon as possible, it becomes quite obvious to achieve its long-term and short-term goals and objectives.
  • Implementation of Better Tools and Technologies for Managing Inventories – They are also one of the significant reasons organizations choose to use better tools, technologies, and strategies for managing inventories.
  • Improvement in Overall Business Conditions – A Faster flow of finished goods signifies better decisions taken by the organization, increased demand, and, thus, a rise in sales. It means that the overall business conditions and the environment have improved, and the organization will surely achieve all its predetermined goals and objectives.
  • Enhanced Demand for Goods – It motivates an organization to come up with strategies that help in the enhancement of the demand for its goods and services. Thus, the higher the demand, the higher the sales and the faster the clearance of finished goods from the inventories.
  • Better Decision Making – If an organization can manage it, the management makes appropriate after considering all the aspects. It hugely helps an organization in making necessary and effective strategies and decisions.
  • Performance Incentives for Sales and Marketing Executives – When there is a rise in demand for goods and services, the sales shall automatically increase, and it will ultimately allow the finished goods to move faster from the inventories. The rise in sales denotes that the company is likely to earn better profits and declare incentives for sales and marketing executives. This, in turn, motivates them to bring in more sales and business to the organization.
  • Developed Planning Practices and Tools – Managing it will allow a company to develop better planning practices and tools and accordingly implement the same for the better.

Disadvantages

The various disadvantages are as follows:

  • Obsolete Inventory – When the finished goods are overstocked, it increases the chances of the same becoming obsolete. This, ultimately, makes the company bear the losses.
  • Storage Costs – More storage shall be needed for the finished goods that are lying, and the company will have to bear more costs for audit, control, additional workforce, etc.
  • Insurance Costs – When there are larger inventories, the insurance costs will automatically increase. If there is a theft, fire, or any other disaster, the company is likely to suffer, and thus, there would be the need to pay higher premiums.

Frequently Asked Questions (FAQs)

What four different types of finished goods inventory are there?

Although there are more types of inventory, the four main ones are raw materials and components, finished goods, work-in-progress, maintenance, repair, and operational supplies.

What ledger does one use for finished goods inventory?

The balance of the job account, as shown by the job account, represents the total balance of the task/work-in-progress. (b) The ledger for finished goods accounts for each manufactured finished good or completed task.

Do finished products inventories represent a cost?

Inventory is one of your most crucial small business costs. If you make your products, both work-in-progress and finished goods will be counted in your inventory. Therefore, you must understand how to accurately determine the cost of your finished goods and reflect it on your balance sheet.

This article has been a guide to what is Finished Goods Inventory. Here we explain its formula using a calculation example and its advantages, & disadvantages. You may learn more about accounting from the following articles –

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