What is average inventory? 

Average inventory refers to the average quantity of stock available in a specified period of time.calculating-inventory-products

The purpose of the average inventory formula is to calculate the value of the inventory within that period of time. This is done by finding out the average of the beginning inventory and end, for the accounting period. Understanding average inventory helps businesses determine how much inventory they need to hold at a given point in time.

Average inventory formula

                                              (Beginning Inventory + Ending Inventory) 

  Average inventory =      ______________________________________________

                                            Number of months in the accounting period

Average inventory calculator

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Let’s say you want to determine the average inventory value for the first two months of the year. Assume that in January you have $6,000 worth of inventory and in February you have $8,000 worth of inventory. Therefore; 

                                        ($6,000 + $8,000)

Average inventory =   ____________________

                                                     2

Average inventory =   $7,000

Understanding the average industry is important when it comes to accounting. Average inventory values are needed for accurate income statements and balance sheets. For companies that sell seasonal goods, their inventory turnover can differ significantly over periods, so averaging over time periods becomes useful to smooth out those differences. 

calculating-inventory-boxeesAverage inventory figures can be used to compare overall sales volume, enabling companies to detect fluctuations in inventory levels that are unaccounted for and may have occurred due to shrinkage, theft or damaged goods. It can also help to account for expired goods. 

Knowing your average inventory is also important because it helps you determine your inventory turnover. Inventory turnover is an important business ratio that measures the number of times inventory is sold or consumed in a given time period. It is important to use average inventory when calculating inventory turnover to smooth out the difference of inventory over the given time period.

Problems with average inventory

There are a few points of contention when it comes to using average inventory;

  1. Discrepancy between monthly figures and daily figures. Average inventory uses month end numbers. For many companies with competitive sales teams, the end of the month usually comes with a big sales push and the first three weeks are significantly slower. Therefore, averaging out the numbers may be misleading to the productivity of the team on a daily basis.
  2. Inaccuracies due to seasonality. If a large amount of your sales happens during seasonal sales, you may face a discrepancy between your numbers at the start and end of the sale season. Companies with seasonal sales may show unusually low inventory balances at the end of the sale season, and a sharp spike in inventory balances just before the start of the season. 
  3. Relying on estimated balances. Some companies use an estimated inventory balance rather than using a physical count to determine the ending inventory. This means that the average formula is itself based on an estimate, which reduces its accuracy.  

Despite these challenges, average inventory is still useful when a company needs to compare inventory with revenue. Income statements present revenue both by month and year-to-date. Your accountant can then compare the year-to-date revenue on the income statement to the average inventory balance to determine how much capital was invested to support the level of sales required.

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