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The average inventory measures how much stock a company holds over time. Inventory balance at the end of each month can vary significantly based on when large shipments arrive and when there is a buying rush or peak season, which can dramatically deplete inventory. An average inventory computation smoothes out such abrupt changes in either direction and provides a more steady estimate of inventory readiness.

Companies generally count inventory at the end of the month, although this figure could be skewed by a sizeable end-of-month stock delivery or a surge in outgoing stock. Averaging over two or more months provides a more accurate view of how much inventory is typically available.

## Understanding Average Inventory

The value of all the things ready for sale or all the raw materials used to make those goods that a corporation stores is referred to as inventory. Inventory management is a crucial focus for businesses since it enables them to better manage their entire business in terms of sales, costs, and supplier relationships.

Average inventory is typically determined by multiplying the number of points required to depict activities throughout a given period effectively.

For example, suppose a company is attempting to determine average inventory over a fiscal year. In that case, the inventory count from the end of each month, including the base month, maybe more accurate. To calculate the average inventory, add the values associated with each point and divide by the number of points.

## Average Inventory Cost

The average cost method determines the cost of inventory items by dividing the total cost of goods purchased or produced in a period by the total number of items purchased or produced. The weighted-average approach is another name for the average cost method.

## Average Inventory Level

The average inventory level describes the number of units rather than their monetary value. It is simpler to determine average inventory level than average inventory cost. There is one less calculation in an average inventory level with no cost assigned to products and simply averaging the numbers.

## Importance of Average Inventory

A variety of events can cause inventory stock changes. While a large delivery can increase inventory, a sales surge during peak season can deplete their inventory. Seasonal enterprises are more vulnerable to fluctuations. However, these elements are transient. One cannot base their inventory stock decisions on these elements.

- Average inventory helps strategically plan the number of goods needed to order from the retailer’s industry.
- It also helps track inventory losses due to inaccuracy, expiration, shrinkage, theft, or accidents.
- The inventory turnover ratio and average inventory period can help determine and assess the time it takes an industry to sell inventory stock.

## What Is the Moving Average Inventory Method?

After each inventory purchase, the average cost of each inventory item in stock is recalculated using the moving average inventory approach. This method produces inventory valuations and cost of goods sold in the middle of those obtained using the first-in, first-out (FIFO) and last-in, first-out (LIFO) methods. This method of averaging produces a financially secure and cautious outcome.

The total purchase cost is divided by the number of items in stock to arrive at this figure. This average cost is then used to determine the cost of terminating inventory and the cost of goods sold. There is no requirement for cost layering, as is required by the FIFO and LIFO approaches.

This approach requires a perpetual inventory management system, which preserves up-to-date records of inventory balances because the moving average cost changes anytime a new purchase is made. A periodic inventory system cannot employ the moving average inventory method because it only collects data at the close of each accounting period and does not maintain individual unit records.

#### Example:

Since the beginning of April, the XYZ industry had 1,000 green widgets in stock at $5 per unit. As a result, in April, the beginning inventory balance of green widgets was $5,000. XYZ then buys 250 more green widgets at $6 each on April 10 for a total of $1,500, and another 750 green widgets for $7 each on April 20 for a total of $5,250.

Without any sales, the moving average cost per unit at the end of April would be $5.88, as calculated by dividing the total cost of $11,750, $5,000 beginning balance + $1,500 purchase + $5,250 purchase by the total on-hand unit count of 2,000 green widgets 1,000 beginning balance + 250 units purchased + 750 units purchased.

## How To Calculate Average Inventory (With Formula and Example)

Add the values of beginning and ending inventory values and divide by the overall period to calculate average inventory:

Average Inventory = (Beginning Inventory + Ending Inventory) / Time Period

A standard method for calculating average inventory for a single month is as follows:

Average Inventory = (Inventory at the month’s beginning + Inventory at the month’s end) / 2

Using this technique, one may track the inventory average each day or any other time.

Examples: A cosmetic firm wants to improve inventory management. Its current inventory in its warehouse is $10,000. This is consistent with the inventory values for the previous three months, which were $9,000, $8,500, and $12,000.

The shoe manufacturer calculates a three-month inventory average by adding the current inventory of $10,000 to the previous three months of inventory, which were recorded as $9,000, $8,500, and $12,000, and dividing it by the number of data points, as follows:

Average inventory = ($10,000 + $9000 + $8,500 + $12,000) / 4

= $9,875

Therefore, $9,875 is the average inventory for the period under consideration.

## How to Use Average Inventory Calculations

The average inventory results can be used for various important accounting and planning purposes. The following are the most common:

Creating an average turnover ratio: The average turnover ratio measures how long it took to sell inventory after you bought it. Divide the total ending inventory by the annual cost of goods sold to arrive at the figure. For example, suppose a retailer has a $30,000 ending inventory and a $45,000 cost of goods sold. $45,000 divided by $30,000 equals 1.5. This signifies that your inventory has been turned (sold) one and a half times during the year.

#### Creating an average turnover ratio

The average turnover ratio measures how long it took to sell inventory after you bought it. Divide the total ending inventory by the annual cost of goods sold to arrive at the figure. For example, suppose a retailer has a $30,000 ending inventory and a $45,000 cost of goods sold. $45,000 divided by $30,000 equals 1.5. This signifies that your inventory has been turned (sold) one and a half times during the year.

#### Calculating the period's average inventory

By definition, average inventory must be calculated across at least two periods. That is, you can take the average of two or more months, quarters, or other periods. Average inventory will decrease the impact of inventory spikes and falls, resulting in a more consistent statistic to base decisions on or compare to other indicators.

#### Calculations for sales support

Average inventory can be used to evaluate how much inventory is required to maintain a certain sales level by comparing it to revenues received from income statements. These comparisons can be made throughout two or more accounting periods and year-to-date. When sales are compared to average inventory data, the average number of units sold to generate sales revenue is shown.

## Average Inventory Examples

#### Example 1:

Let’s take a furniture company, for example, with a current inventory stock of Rs.10,000. This is calculated using the inventory stock from the previous three months, which was worth Rs.7,00,000, Rs.5,00,000, and Rs.6,00,000, respectively. As a result, the average inventory for the furniture company will be determined as follows:

Average inventory = (Rs. 10,000 + Rs. 7,00,000 + Rs. 5,00,000 + Rs. 6,00,000) / 4 = Rs. 7,00,000

#### Example 2:

The proprietor of a local supermarket wants to know if the first semester’s average inventory matches the first quarter’s average inventory. The average inventory was $10,000 in the the first quarter; indicating that in January 2019, the average value in the supermarket warehouse was $10,000. For February and March 2019, the identical figure was used.

We’ll require the month-end inventory for April, May, and June 2019 to compute the average inventory for the first semester. The warehouse manager recorded the following value:

April 2019: $ 12,000

May 2019: $ 7000

June 2019: $ 11,000

Average inventory = $10,000 + $10,000 + $10,000 + $12,000 + $7000 + $ 11,000 / 6

= $10,000

The average inventory for the six-month period is the same as the average inventory for the year’s first quarter. It suggests that sales are relatively stable and that volatility is low.

## The Limitations of Average Inventory

Calculating the average inventory calculation for your company can be a wise decision. However, it also comes with its set of flaws. Some factors to consider before applying the formula are as follows:

#### Fluctuations in monthly and daily sales

Since the average inventory method considers data from a variety of dates, there can be a significant difference between your daily inventory and those obtained from more considerable periods. In the same way, most businesses report their highest sales figures towards the end of a specific period. As a result, data might be skewed, offering an inaccurate picture of a firm’s sales and productivity.

#### Fluctuations according to the seasons

Average inventory figures are likely to be erroneous for organizations whose product sales are seasonal. This is especially true with inventory levels. For example, in a strong sales season, you will have a significant volume of inventory at the beginning of that term. Hopefully, that burden will be substantially reduced by the term’s end. Although this is not an apparent reason to avoid using the average inventory method, it is something to consider when reviewing your operational figures.

#### Expected Balances

Using the average inventory formula with an expected inventory balance rather than the actual quantity will almost certainly be a disaster. Problems emerge in this instance because your initial numbers are estimates rather than exact figures. That means your average inventory depends on an estimate.

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## FAQs

An inventory’s average amount or value across two or more accounting periods is referred to as average inventory. It is the average value of inventory over a specified period. That value may or may not be the same as the median value calculated from the same data.

Average stock, or average inventory, is equivalent to the total number of stock at the start and end of the period divided by two. It shows a company’s investment in its inventory.

Add the opening inventory to the closing inventory and divide by two to get the average inventory; the result will be the daily inventory utilization. The variance in average inventory can indicate the nature of the firm and the degree to which it is volatile.

Add the inventory counts at the end of each month and divide by the number of months to obtain the year’s average inventory. Remember to include the base month in your fiscal year average inventory calculations, dividing the total by 13 months rather than 12.

Divide the cost of average inventory by the price of items sold and multiply by the period length, which is usually 365 days.