Inventory management is critical for managing costs and ensuring customer satisfaction. When there is too much inventory on hand, capital is being held up unnecessarily and may even be risked.
The average inventory calculation is a useful accounting measure for tracking changes and activities over time. This is frequently a better lens through which to view a company’s inventory status than a single point in time or accounting period.
What is Average Inventory?
Average inventory is the mean estimation of stock or set of products inside a specific time-frame, which may differ from the median value of a similar information set.
The reason to calculate the average inventory is to estimate the stock or inventory within that specified time period. This is done by finding out precise values of the average inventory at the beginning and end as well, for the accounting period. Understanding average inventory assists an organization or business to determine how much inventory they need to hold at a given point as expected.
Calculation of Average Inventory Value
To calculate the average inventory stock, take the current time frame inventory balance, and add it to the starting period inventory balance. Then, divide the total by two to get the value of the average inventory.
Average Inventory Value Formula:
Average inventory value formula calculation example;
Let’s suppose we have $10,000 beginning inventory and $12,000 of ending inventory. The total number of months is 2. So, now by adding $10,000 and $12,000 and dividing it by 2 we get the final value or result of the Average inventory i.e., $7000.
Calculation of Average Inventory Count
To calculate average inventory count is almost the same method as average inventory value calculation but it’s slightly different. Add the stock of every month and divide them by the total number of months.
Average Inventory Count Formula:
Let’s suppose the inventory stock count of the first month is 700 and 400 for the second month. Add both months’ stocks count and then divide the value by 2, we will get the average inventory count.
This means 550 items of inventory in stock, representing the worth of $11,000 inventory.
Understanding Uses of Average Inventory
Understanding the average inventory is significant with regard to accounting. Average inventory values are required for precise income statements and monetary records. For organizations that sell seasonal merchandise, their inventory turnover can differ fundamentally over periods, so averaging overtime periods get helpful to streamline those distinctions.
Average inventory figures can be utilized to think about general deals or sale volume, empowering organizations to distinguish changes in stock levels that are unaccounted for and may have happened because of shrinkage, theft, or damaged products. It can likewise assist with expired products.
Stock Analysis encourages the executives to comprehend its Purchase and Sales pattern, which helps them to arrange Inventory in a better way to evade the issue of stock-outs and furthermore to avoid the expense of abundance Inventory as that can bring about the strain on the finances of the organization. It also helps in the calculation of different valuable ratios:
- Inventory Turnover Ratio: By using average inventory value we can derive inventory turnover ratio. Here is the formula:
Inventory Turnover Ratio= (Cost of Goods Sold/Avg Inventory)
- Average Inventory Period: By using inventory turnover ratio we can calculate the value average inventory period. Here is the formula:
Average Inventory Period = (Number of Days in Period/Inventory Turnover Ratio)
Problems with Average Inventory Formula
- One of the significant issues is its calculation dependents on the Ending Inventory Balance of the period, which may not be a genuine agent of the Average of the period.
- It isn’t a good assessment tool for business, which is occasional as their occasional or seasonal shifts impact their sales. Any Inventory arrangements and planning dependent on the Average Inventory will bring about loss of sales during the peak season time and abundance of Inventory during the non-peak time period. Woolen Industry is a good example to understand.
- Most of the businesses give an estimate of the Ending Inventory instead of making the most of a precise Inventory count, which again results in influencing the calculation of Average Inventory, which itself depends on the Mean of Beginning and Ending Inventory.
Final Thoughts on Calculating Average Inventory
It is utilized to quantify the amount of Inventory that a business typically holds over a more extended time period. It is basically the average between the Inventory level announced during the Beginning of the estimated time frame and the finish of the estimated time frame. It holds importance as the Income Statement (covers a timeframe), and the Balance Sheet speaks to the situation as on a specific date in particular.
Thusly, when contrasting the business Sales level and its Inventory level, it bodes well to utilize Avg. Stock aids in investigating the amount of Inventory Investment is needed to help a given degree of sales for the business.
Inventory becomes more significant in the case of businesses that are seasonal or occasional and needs to develop more Inventory than the standard Average for the rest of the non-seasonal period to compensate for the expanded interest during the peak season.
Stock Holding gives different bits of knowledge into the performances of an organization and the development of Inventory all through business, which can additionally stay into by the administration to settle on better business choices.