Purchases in business accounting are not just transactions for acquisition of goods. They form the most essential aspect of measuring a firm’s financial performance. Calculating purchases plays a significant role in developing forecasts and budgets. In other words, you can make informed decisions that ultimately affect profit and business growth.
That’s why it is essential to learn how to calculate purchases from balance sheet. With practical examples we’ll showcase a step-by-step approach to the calculation of purchases. You will also learn about the common mistakes to avoid, and how these numbers influence things like cash flow and profit.
Understand The Key Financial Statements
The balance sheet and income statement offer a unique snapshot of a company’s health. The balance sheet outlines what the company owns (assets), what it owes (liabilities), and what’s left over for the owners (equity). On the other hand, the income statement tracks all the revenues and expenses, giving you the bottom line such as profit or loss.
Inventory and purchases have a direct connection to the Balance Sheet. Think of inventory as what a company has in stock. It can be things they plan to sell. When they purchase goods to restock inventory, it increases the “Current Assets” section of the Balance Sheet.
Now, when those goods are sold, they shift to the Income Statement, showing up as “Cost of Goods Sold” (COGS). In short, inventory reflects what’s on hand right now, while purchases represent what’s been added to stock.
Formula for Calculating Purchases
You can easily calculate the inventory purchases by using a simple formula. The formula is:
Purchases = Ending Inventory + COGS – Beginning Inventory
Now, let’s clarify each component in detail:
Purchases
Purchases are the total cost of acquiring goods and materials for production. This includes raw materials, finished goods, freight charge, etc.
Ending Inventory
After ending a specific time period, the leftover stock value is considered ending inventory. The ending inventory includes everything you have on stock or in the warehouse. Ending inventory can change due to factors like sales, spoilage, or even theft.
Cost of Goods Sold (COGS)
COGS is the total cost of everything sold during the period. It includes what you paid for raw materials, production, or any items bought for resale.
Beginning Inventory
Beginning inventory is the value of inventory that you had on hand at the start of an accounting period. As the term implies, it’s your starting point. It’s the anchor that connects the past to the present.
How to Calculate Purchases from Balance Sheet
Calculating inventory purchases requires following some numbers from the balance sheet and income statement.
Step 1: Locate Beginning and Ending Inventory
Look for the inventory section in your balance sheet. This should be under current assets. From there, you’ll see the beginning inventory (the amount at the start of the period) and ending inventory (the amount at the end).
Step 2: Find the COGS from the Income Statement
Now, look for Cost of Goods Sold, or COGS in the income statement. That’s the total cost tied to the goods that you sold during that period. This figure gives you insight into your production costs or purchase costs.
Step 3: Use the Formula and Calculate
Start by noting your beginning inventory, ending inventory, and the cost of goods sold (COGS).
Then, apply the formula:
Purchases = Ending Inventory + COGS – Beginning Inventory
Here, your beginning inventory is what you had at the start, COGS represents what was used or sold, and ending inventory shows what’s left. By combining these, you can figure out how much was purchased.
Calculating Purchases from the Balance Sheet
Let’s assume you own a small bakery. At the beginning of the year, you had $4,000 worth of goods for production. That’s what we call Beginning Inventory. Then throughout the year, you baked hundreds of cakes and cookies and ended up spending $10,000 on ingredients. That is known as your Cost of Goods Sold (COGS).
Following the use of everything by the end of the year, you are still left with some flour and sugar at a value of $2,500. That will be your Ending Inventory.
That means,
- Ending Inventory = $2,500.
- COGS = $10,000.
- Beginning Inventory = $4,000
Now, plug those numbers into the formula:
Purchases = Ending Inventory + COGS – Beginning Inventory
= 500,000
= $2,500 + $10,000 – $4,000
= $8,500
= Purchases
After performing the calculation, the result for Purchases from the Balance Sheet is $8,500.
Common Mistakes to Avoid
It’s easy to mess things up when you’re dealing with purchases and inventory calculations. These mistakes can ultimately affect your assessment and future decisions. The common mistakes to avoid while calculating purchases from balance sheet are:
Mixing Up COGS and Purchases
One of the biggest mistakes during inventory purchase calculation is confusing COGS with purchases. COGS, or Cost of Goods Sold, is the total cost of goods that have been sold during a certain period. But purchases are the goods you buy to restock your inventory. They’re connected, but not the same thing. If you get these mixed up, your calculations could go off-track.
Getting the Beginning and Ending Inventory Wrong
People often get the beginning and ending inventory values mixed up. If you get your inventory periods wrong, you’re basically setting yourself up for a domino effect of errors. Here, ending inventory is the unsold items at the end of the accounting period. And beginning inventory is the goods available to sell at the start.
Not Accounting for Returns and Discounts
People typically forget to adjust for returns and discounts. Returns and discounts can mess with your numbers. If you don’t account for them, your purchases could look higher or lower than their actual value.
Ignoring Accrued Expenses
Accrued expenses don’t show up in the immediate cash flow. But they can mess with your inventory figures if not counted properly.
Letting Your Records Get Sloppy
If your records aren’t up-to-date or if you’re not using the right data source, you could get inaccurate information. Keep your documents neat and organized.
Why It’s Important to Calculate Purchases
Purchases are the cost of buying goods or raw materials. The accurate amount of purchases is essential for calculating the cost of goods sold. And ultimately finding out the profitability. If you mess up here, your cost of goods sold (COGS) and profits won’t reflect reality. And it can seriously skew your financial analysis. The other important factors are:
Impact on Cash Flow
The money you spend on purchases has a major role in cash flow. Excessive purchases can drain your cash and strain your finances. because it’s all tied up in inventory you haven’t sold yet. With too much inventory sitting around, you’re essentially paying for storage space. So, accurate purchase calculation is necessary to keep the balance in selling and buying.
Managing Your Budget
Accurate purchase calculations help you predict expenses and keep everything in line. The purchase pattern will help you to create realistic budgets. This will also help you to improve cost control by allocating resources effectively.
Controlling Inventory
Purchases are directly involved with inventory levels. These two combined have a great effect on production and sales. Miscalculation of purchases can lead to overstocking or stockouts. Which can have a great impact on capital, expenses and overall profits. Thus, keeping your inventory levels balanced is essential. And the only way to do that is by understanding your purchase figures inside and out.
Conclusion
Figuring out inventory purchases is a valuable step for keeping your finances in check. You just need to know the right equation method. Find out the proper ending inventory and subtract the accurate COGS from it. Now add the result with the beginning inventory in hand and you will get your purchase amount.
Making this calculation a regular part of your process gives you better control over your budget, cash flow, and inventory planning. It might feel like a small detail. However, it makes a huge difference in the bigger picture. Hence, you should consistently check your purchases with the right equation method.
Frequently Asked Questions (FAQs)
How does this method differ from calculating purchases directly?
Calculating purchases using the formula helps link inventory changes with COGS. It’s not as straightforward as direct purchases. It accounts for changes in stock over the time, giving a more precise picture of inventory.
Can I calculate purchases without COGS?
Technically, you can’t. Without COGS, you’re missing a key piece of the equation. But you can estimate the COGS amount with this formula: COGS = Sales – Gross Profit. Though it wont give you a fully accurate result.
What should I do if I can’t find COGS or inventory data?
If you can’t find this data, you might need to dig deeper into your financial records or estimate figures. You can estimate the COGS amount with this formula: COGS = Sales – Gross Profit. Also, check your purchase records directly to have an estimation of total purchases.
How do purchases affect the balance sheet and income statement?
Purchases appear initially as part of the inventory in the balance sheet. When purchases increase, the inventory as a current asset in the balance sheet also increases. If the goods are sold, the cost is moved to the COGS section of the income statement reducing the net income.
Is the purchases calculation the same for different industries?
Not really. Since different industries have different inventory management needs the calculation also may differ. For instance, a manufacturing company would need to account for raw materials while a retailer would deal with finished goods only.
