What is moving average cost and why is it important to my business?
A company that sells goods keeps a healthy inventory to serve the needs of its customers. There are various accounting principles and computations that are used by a company, some of which are applied to keep track of goods sold and goods in stock. Updated on 16th June 2020.
One of these principles is computing average cost, wherein one of the methods is called moving average cost.
“A moving average (unit) cost is an inventory costing method wherein after each goods acquisition, the average unit cost of the item is recomputed. This is done by adding the cost of the newly-acquired goods or units to the cost of the units already in the inventory. This is then divided by the new total number of items. It is a way to calculate the ending inventory cost. It is a perpetual process as there will be purchases and sale of goods throughout the year.” Source: Business Dictionary
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The importance of moving average cost
It is important for a company to sell its products and reduce the stock it has on hand. It’s easy to make an inventory of items that can be counted individually, but how will a company do its accounting when the goods it sells are in bulk, such as liquids, nuts, nails and bolts, grains, crude oil, wires and cables? Most of these items are carried in large quantities.
To illustrate the value of moving average cost, let us say a company is selling gasoline. There’s 50 gallons of gasoline still left in it and fresh delivery adds 200 gallons. It will be impossible to separate the old and new stock. Likewise, the new delivery will have a different price from the old one. This is where the moving average cost is applied: to properly account the product and compute your new selling price.
The moving average gets updated as soon as new delivery is received. TradeGecko online inventory management software, will automatically calculate a new average which will be used across your sales and inventory reports.
The moving average helps you keep track of your financial position. It is used when recording inventory and computing your assets, in computing your net sales and the cost of goods sold to come up with your gross profit computation.
Computation of moving averages might sound complicated, but it is the best way to give you the most current price to use in your business.
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