Calculate average inventory
Average Inventory Explained: Calculation Formula & Examples
The importance of inventory management and how to calculate it can’t be understated. And yet, 43% of small businesses in the United States don’t monitor inventory. A lack of real-time data on your inventory can lead to too much or too little stock.
But it’s not too late to know how to calculate average inventory so that you can stay on top of your game. In this detailed guide, Upscribe looks at the average inventory definition, formula, and example. Read on to discover more.
What Is Average Inventory?
Let’s start by explaining what inventory is.
Inventory refers to the raw materials for manufacturing and goods for sale. You can further divide the inventory into raw materials, work-in-progress, and finished goods.
Average inventory is a calculation to determine the value of inventory over two or more accounting periods (months or quarters). It represents the average amount of stock you have over a specific time. To calculate average inventory, you need to add the total inventory you had at the beginning of a period to the amount you have at the end of a period, then divide by the number of periods measured.
Alternatively, you can add inventory from multiple periods, then divide by the total periods measured. Generally, this provides a clearer picture of your actual average than simply calculating your beginning and ending periods.
With average inventory, your business can know how much inventory is available for sale or production. You can also use average inventory figures to compare sales volume in different accounting periods. The feedback can be handy in monitoring inventory losses and ensuring that you don’t over or under-order stock.
Average Inventory Examples
Here are examples of average inventory to help you grasp the whole concept.
1. Four-month inventory average
GalaxyTech is a smartphone manufacturing company that wants to improve its inventory management. Its current inventory is worth $50,000, with inventory figures for the previous four months of $20,000, $14,000, $30,000, and $13,000.
Their equation would look something like this:
Average Inventory= ($50,000 + $ 20,000+ $ 14,000 + $ 30,000 + $13,000)/ 5
GalaxyTech’s average inventory over the five accounting periods is $ 22,800
2: Two-month average inventory
Tom owns an e-commerce store that supplies children’s toys. His business has been booming because of the COVID-19 pandemic. So he wants to find out the value of his stock in the previous quarter.
In the quarter, Tom’s online store started with 45,000 units and ended the quarter with 2,500 units. He decides to calculate his average inventory as shown below:
Average inventory = (Beginning inventory + Ending inventory) / Months in the period
Average inventory = ( 45,000 + 2500) / 2
Average inventory = 23,750 units.
Therefore, Tom understands that he had 23,750 units in stock during the previous accounting period.
How to Calculate Average Inventory
Working out the average inventory is straightforward. Here are several ways of doing that:
To calculate average inventory, divide the beginning and ending inventory values by the total period:
Average inventory = (Beginning inventory + Ending inventory) / Period
Typically, a business calculates inventory over one month as follows:
Average inventory = (Inventory at the beginning of the month + Inventory at the end of the month) / 2
By using this formula, you can also monitor inventory every day or for any other period. For example, you can add the total inventory over several periods (quarters or months) and then divide it by the number of accounting periods.
See the example below:
(1st Quarter + 2nd Quarter + 3rd Quarter)/ 3
Average Inventory Formula
Let’s summarize everything with a formula to work out the average inventory on hand across a particular period:
Average Inventory = (Beginning Inventory + Ending Inventory) / 2
Use the following method to calculate the average inventory per specific period over a longer time:
Average Inventory = (Beginning Inventory + Ending Inventory) / Number of Periods
What Is Inventory Turnover Ratio?
The inventory ratio is a data point showing how much time your business takes to convert stock on hand into sales. It’s a relevant metric that indicates whether you have excess stock and helps you enhance inventory management.
For example, a high turnover ratio shows you can replenish your stock and sell it to end users as fast as you can. However, it can also demonstrate that you have too much stock on hand if the ratio is low. Excess inventory could be due to overbuying or a lack of collaboration between the sales and purchasing teams.
How to calculate the inventory ratio
First, find the average inventory and the cost of goods sold (COGS). COGS measures the cost of producing your products plus labor, materials, and more. You can find this figure on your income statement.
Benchmark your business against peer company ratios to see how you’re performing.
Use this formula:
Inventory turnover ratio = Cost of goods sold / average inventory
As an example, consider Galaxy Tech’s average inventory of $22,800 and its cost of goods sold of $88,160. Therefore, the average inventory turnover ratio for the five months is 88,160/22,800, which equals 3,8.
To meet customer demand and increase sales, GalaxyTech had to restock an average of 3.8 times over the five months.
What about DSI?
DSI looks at the average number of days it takes for your company to sell off its inventory. You can easily calculate this figure if you have an average inventory.
DSI = average inventory / COGS X 365
DSI is a valuable estimate if your business is in distribution, and it helps you manage storage and holding costs. These costs decrease if each item spends less time in stock. For instance, what if a product’s annual storage cost is 20% and it spends five months in inventory?
How much should you pay for holding costs to keep the item in the warehouse? The answer is 5% (20%/5). DSI varies by industry, so benchmark it against other businesses in your sector. A high DSI indicates hard-to-sell stock or poor inventory management.
Why Is Average Inventory Important?
Prevents understocking or overstocking
Keeping track of your average inventory over two or more specific periods can help you determine how much stock to order. For example, Tom knows that on average, his online shop must have nearly 24,000 units.
As a result, having the correct data on average inventory can help you avoid understocking or overstocking. Understocking occurs when your business doesn’t have enough inventory on hand to satisfy current demand. It leads to a drop in sales and a potential loss of customers.
Overstocking means you have more inventory than you need to serve your customers’ needs. It can lead to tied-up cash and skyrocketing operational costs.
This will certainly harm your profits. But with better inventory management practices, you’ll have fewer stock-outs and overstocks. With solid management, you can reduce inventory costs by 10%.
Improves inventory management
Because you have accurate data on your average inventory, it’s easy to track your stock of raw materials, work-in-progress, or finished goods. You can keep an eye on inventory losses due to theft, shrinkage, inaccuracy, or accidents. These analytics help you take immediate action to reduce your losses.
Provides valuable insights on inventory turnover
Inventory turnover shows the number of times your business sells and restocks goods over a specific period. Average inventory and the inventory turnover ratio indicate how long it takes you to sell your inventory stock.
For example, a high inventory turnover indicates a positive demand for your goods, and you must keep sufficient quantities on hand to meet customer needs. A continuous drop in inventory turnover shows low demand for those products.
Average inventory numbers help you improve your bottom line. As time passes, you’ll become aware of what products you need to support your sales.
Leverage the power of product subscriptions to gain control over your inventory
It’s possible to avoid having surplus inventory if you adopt a subscription model for your ecommerce store. That’s because you can accurately predict the stock of goods you should order and supply. And your subscribers can commit to buying a specific amount of inventory in a given period.
As a result, a platform like Upscribe has the best tools to let you manage product subscriptions and prevent excess stock. It’s a subscription management tool for your online store to help you enhance the user experience and double revenue.
Average inventory represents the mean value of your inventory over a particular period. Inventory refers to raw materials, work-in-progress, and finished goods. A simple way to calculate average inventories is to add beginning and ending inventories and divide that total by the number of specific periods.
Calculating average inventory is vital because it improves your inventory management. You also require a tool to prevent excess inventory and sales loss if you run a product subscription-based business. Upscribe is the best subscription management platform with relevant features to simplify your inventory management and grow sales by 10x. Book a demo with us today and start streamlining your subscription service today!