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Four cost formulas you can use to work out your inventory costs

by , 30 July 2014
To ensure the selling price for your goods is accurate, you must work out your inventory costs. You must do this correctly or you could sell your products at a loss or for too much.

Now there are a few things you must remember when it comes to working out your cost of inventory. For example, you must calculate your cost of purchase, cost of convenience and other manufacturing cost. But you mustn't include abnormal waste expenses, storage costs, administrative overheads and selling costs.

But how do you use these to work out your inventory cost per item.

Well that's easy if you use any of these four methods in your inventory valuation...

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You can easily work out your inventory costs with these four methods

 
Method 1: Standard cost method
In this method, you add all of your applicable manufacturing costs together and divide by the number of items you produced. This will give you the expense per item you produce.
 
Method 2: Specific identification of costs
You must use this method if you produce a number of completely different items. For example, if you manufacture TVs, fridges and washing machines, all of these have very different costs to make. You'd calculate their price depending on their specific expenses. Then set your selling price standard so you can know TVs cost R5 000 and fridges cost R4 000.
 
Method 3: The first-in, first-out (FIFO) method
In this method, the inventory stock you purchase first is the one you must use first. So even if you buy newer stock, you must still use the older stock first. 
 
With this method, if the price of your stock goes up you won't change your selling price until you use the more expensive stock. 
 
Method 4: Weight average method
With this method, you take the total amount of stock you have and add up all the costs. You then divide that by the units you have to get the weighted average. For example:
 
Stock: (20kg at R10 per kg = R200) + (50kg at R11 per kg = R550) = R750
 
Weighted average: R750/70kg = R10.71
 
So ensure you use one of these four cost formulas when you work out your inventory costs.
 

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