Average inventory is the average quantity of inventory available in a company during a specified period. In other words, it means the value of an inventory within a specified period. It is measured on the last business day of each month. Therefore, it is calculated for a longer time, generally more than one month, like a trimester or a year.
Average inventory is also understood as the calculation you may use to find out how much inventory you have over a specific time period. When you calculate average inventory, it takes the mean average over a longer period of time for providing a clearer picture of how much inventory is normally on hand.
What is Average Inventory?
Definition: Average inventory is defined as a calculation used to find out the value of the number of goods or inventory during two or more specified time periods. It is the estimation of the inventory used to determine how much inventory a company has over a specified period.
Inventory is the value of goods that are ready for sale or the raw material used to create these goods that a company would store. A business needs to manage inventory successfully. Successful inventory management allows companies to manage their overall business in terms of costs, sales, and relationships with their suppliers.
The inventory at two points cannot represent the changes in the inventory accurately over the period. Therefore, average inventory is frequently used by many companies to manage the inventory in the business accurately. The average inventory is used by businesses to track the inventory losses that may have occurred during a specified period. The reason for that loss can be theft, shrinkage, or damaged goods caused by mishandling. This calculation also accounts for any perishable inventory that may have expired during the specified period.
The benefit of using average inventory is that it becomes easier for a company to determine how much inventory a company needs to support its sales requirement. It helps the businesses to know the desirable inventory as carrying less, or high inventory can be detrimental to the business.
Why Use the Average Inventory?
Average inventory lets you have a better understanding of the amount of inventory you have, plus it also tells you whether those amounts are too high or too low. In addition to this, it will also provide you insights regarding-
- Overall sales volume
- Inventory turnover
- Inventory losses related to shrink and theft
- Inventory loss due to expired product
- Inventory loss due to damages, etc.
Average Inventory Formula
You can use the average inventory formula for calculating the mean value of Inventory at a certain point in time. For this, you need to take the average of the Inventory at the beginning and at the end of a specific accounting period.
As ending inventory can face a sudden drawdown of inventory or it may also see a large supply of inventory, straight away and that is why the average inventory formula takes care of such spikes by taking the mean value of both the beginning and ending Inventory. Formula to calculate average inventory can be depicted in two ways-
Average Inventory = (Beginning Inventory + Ending Inventory) / 2
Average Inventory = (Current Inventory + Previous Inventory) / Number of Periods
Example of Average Inventory
Suppose a shoe company has current inventory in its warehouse, which equals INR 400,000.
This is in line with the inventory for the two previous months, which were valued at INR 300,000 and INR 500,000. Now the company wants to do inventory management.
Therefore, the calculation of average inventory is best suitable in this respect. The average inventory of the three months is calculated as:
Average inventory = (400,000 + 300,000 + 500,000) / 3 = INR 400,000
Where Average Inventory Formula can be Used?
Companies can use the formula for average inventory to calculate various ratios, including Inventory Turnover and Average Inventory Ratio.
1. Inventory Turnover Ratio
Inventory turnover ratio is the ratio used by businesses to measure how quickly their inventories are moving. It provides a better understanding of the inventory that a company may want in a given period. The formula for calculating the Inventory Turnover ratio is:
Inventory Turnover ratio = Cost of Goods Sold / Average Inventory
A high inventory turnover ratio means that a company has solid sales and they are not keeping enough stock on hand and vice-versa.
2. Average Inventory Period
The calculation of the Average inventory period helps the companies to have a better understanding of the time that is required for turning the inventory into sales. The formula for calculating the average inventory period is:
Average Inventory Period = Number of Days in Period / Inventory Turnover Ratio
In this case, a good average inventory period varies between companies and products.
Moving Average Inventory
For better inventory management, a company may use the software. A company may choose moving average inventory when it is possible to have a perpetual inventory tracking system. A moving average inventory allows the businesses to adjust their inventory items based on information from the last purchase.
The use of software can help companies to track their inventory in real-time with each transaction. A moving average inventory gets constantly updated automatically with each transaction. Following are the reasons because of which companies move towards the average inventory approach:
1. It provides the ability to compare the inventory averages across multiple periods.
2. It provides a better comparison of the items that have a more volatile sales pattern.
3. It is much easier to calculate the average cost of goods sold.
Finding average inventory is one of the most effective ways of doing inventory management like a pro.
One of the key benefits of utilizing the average inventory formula is that when used along with the revenue statements, it will become easier to find out how much inventory you need to have available for supporting your support sales.
When you either have too much inventory or have too little inventory, it can be detrimental to your business growth. Calculating the average inventory will safeguard you from all such issues.
How important do you find average inventory calculation for a business?