Knowing how to calculate average inventory is an important tool for determining the value of your inventory on hand. Using this article, you can find the formulas and calculations for your accounting purposes.
Inventory management is going to be the backbone of your business — and the bane of your inventory manager’s existence.
Have too much inventory to hand, and your profit margin will decrease. Have too little, and you’ll find yourself quickly running out. When it comes to keeping inventory, it’s a never-ending balancing act.
Those practicing lean inventories obsess over finding the ideal inventory amount, and many achieve this by learning how to calculate average inventory.
Read on to learn how to calculate the inventory turnover rate for your business, including all the necessary formulas for calculating your beginning and ending inventory.
Just here for the key takeaway?
Here are the formulas for calculating inventory levels and understanding how to calculate average days in inventory:
Confused? Read on as we’ll explain these formulas, with examples of inventory calculations later.
Average inventory estimates the amount or value of inventory a company has over a specific time.
This figure is important for businesses because it helps them make a budget and plan for future inventory needs. Additionally, average inventory can be used to assess a company’s overall financial health. There are a few different ways to calculate the average inventory.
The most common method is to take the total inventory value at the beginning of a period, add it to the total value at the end of the period, and divide it by two.
Another way to calculate the average inventory is to take the total cost of goods sold (COGS) during a period and divide it by the number of days in that period.
Regardless of the method used, the average inventory provides valuable information that can be used to make important business decisions. For example, if a company’s average inventory increases over time, it may need to invest in more storage space or hire additional staff to manage the inventory. On the other hand, if a company’s average inventory level is decreasing, it may be able to cut costs by reducing its items on hand.
Overall, average inventory is a helpful tool for businesses of all sizes.
By understanding and tracking their average inventory, companies can make informed decisions about their inventories and ensure that they are meeting their customers’ needs.
There are a few ways you can use the results of your average inventory calculations.
For example, you can use them to help you determine how much inventory you need to keep on hand or to help you budget for future purchase orders for raw materials and components.
Average inventory calculations can also be helpful when it comes to forecasting future overall sales volume. Knowing how to determine how much inventory you typically have on hand can better estimate how much product you’ll need to sell to meet your sales goals.
Finally, average inventory calculations can also be used to monitor your inventory levels over time.
When you calculate the average inventory levels, you can spot trends that indicate a need for adjustments in your purchasing or production plans. So, as you can see, there are various ways that average inventory calculations can be used to benefit your business.
There are a few reasons why it’s important to look at your average inventory rather than just your current inventory.
First, your inventory will fluctuate.
One month you might get a massive delivery due to increasing orders. Or maybe you sell seasonal goods, like ice cream in the summer or holiday decorations in winter.
For situations like this, looking at one point in time isn’t going to give you an accurate picture of your inventory since the amount of time inventory levels changes is frequent.
Another reason to look at your average inventory is that it helps you spot trends and make predicitions for future sales. For example, if you see that your average inventory is slowly increasing over time, that could be a sign that you need to adjust your ordering process. On the other hand, if your average inventory is decreasing, that could be a sign that you’re not ordering enough to meet customer demand, and you’ll start losing overall sales volume.
Looking at your average inventory can also help you make decisions on resource capacity planning like storage space and staffing. If you know that you typically have a certain amount of inventory on hand, you can plan accordingly. For example, if you need to store more inventory during the holiday season, you can rent a larger storage unit or hire additional staff to help manage everything.
In short, looking at your average inventory can give you a more accurate picture of your business’s needs than looking at your current inventory alone.
It can help you spot trends and make better decisions about storage and staffing.
A few challenges come with using the average inventory formula to value inventory.
First, the formula assumes that all of the inventory on hand is sold evenly throughout the year. This isn’t always the case, as some items may sell more quickly than others. This can lead to an inaccurate inventory valuation if not accounted for properly.
Another challenge is that the average inventory formula only considers the cost of goods sold. It doesn’t consider other important factors such as:
This can lead to an underestimation of the true cost of inventory.
Finally, the average inventory formula doesn’t account for price changes over time. If prices go up or down, this will impact inventory valuation. This is why it’s important to keep track of prices and adjust the formula accordingly.
Despite these challenges, an average inventory formula is still a helpful tool for valuing inventory.
You can get a more accurate picture of your true inventory costs by accounting for these factors.
PRO TIP: Using average inventory formula and calculations isn’t foolproof. Thre are many factors that can cause inconsistencies when carrying inventory. It’s important to learn how to correct inventory losses should a mistake arise.
The inventory turnover ratio is a way of measuring how quickly inventory is moving through a business.
It’s calculated by dividing the COGS by the average inventory.
A high inventory turnover ratio means that inventory moves quickly and efficiently through the business. This is generally seen as a good thing, as it indicates that the business is selling its products or services promptly and not tying up too much capital in stock.
On the other hand, a low inventory turnover ratio could indicate that the business is struggling to sell its products or that it’s holding onto too much stock.
This can tie up working capital and lead to cash flow problems down the line.
Generally speaking, an inventory turnover rate of 2-3 is considered healthy. But the ideal ratio will depend on the industry and the type of business. For example, businesses that sell perishable goods will need to turn over inventory much more quickly than businesses that sell durable goods.
The inventory turnover ratio is just one tool that can be used to measure the health of a business.
Before making any business decision, be sure to look into other factors too, such as profitability and cash flow.
Understanding average inventory for two or more accounting periods, use the following formula:
Average Inventory = (Beginning Inventory + Ending Inventory) / 2
For example, if your company’s beginning inventory for January is $10,000 and the ending inventory for January is $15,000, the average inventory for January would be $12,500.
This formula can be extended to cover longer periods, like adding up the inventory at the end of each month in a year and dividing it by 12. You can look at smaller timeframes, like examining a single month by taking an inventory at the beginning of the month and the end of the month and dividing it by 2.
Looking at average inventory is a good way to get a general idea of how much inventory a company has.
It can help forecast future inventory needs and make decisions about safety stock levels. When calculating average inventory, it’s important to use consistent methods and timeframes to compare results over the amount of time items are stored accurately. Otherwise, you may not be getting an accurate picture of your company’s inventory levels.
If you’re starting a new business, you won’t have any previous accounting periods to use for reference.
In this case, you’ll need to calculate your beginning inventory from scratch. Here’s how:
This will give you your average cost per item.
You can then use this number to calculate the value of your beginning inventory. If you have a business with inventory, it’s important to keep track of your beginning inventory. This will give you a better idea of your overall inventory costs and help you make more informed decisions about your stock.
If you don’t have the previous accounting period’s ending inventory, you’ll need to calculate the beginning inventory. You’ll need to know the cost of goods sold and the ending inventory for the current accounting period.
To calculate COGS, use the following formula:
COGS = Beginning Inventory + Purchases – Ending Inventory
Once you have the cost of goods sold, plug it into this formula to calculate the beginning inventory:
Beginning inventory = COGS – Purchases + Ending Inventory
For example, let’s say that your company’s cost of goods sold for the current accounting period is $10,000. You also made $5,000 in purchases, and your ending inventory is $2,000. This means that your beginning inventory must have been $3,000.
For calculating ending inventory, you will need to know the period’s beginning inventory, purchases, and sales. The formula is:
Ending inventory = Beginning Inventory + Purchases – Sales
For example, if your business started with $10,000 in inventory, made $5,000 in purchases during the period, and had $6,000 in sales, calculating ending inventory would be calculated as follows:
Ending inventory = $10,000 + $5,000 – $6,000
Therefore, the ending inventory value for this example would be $9,000.
Don’t fancy yourself as a mathematician? Here’s an alternative many companies use to navigate of having to perform manual stock takes and equations.
How to calculate average days to sell inventory
The average days of inventory before selling (also called days inventory outstanding or DIO) measure a company’s number of days to sell its inventory. This metric is important because it can give insights into a company’s operating efficiency and effectiveness in managing its inventory levels.
Calculating the average inventory days to sell products is simple and only requires a few pieces of information:
(Ending Inventory / Cost of Goods Sold) * Number of Days in Reporting Period
Many manufacturers implement a perpetual inventory valuation method in their business for real-time records of inventory movement.
This valuation method is achievable with computerized point-of-sale (POS) systems and inventory management software that can help you monitor inventory movements live to reflect inventory changes immediately. Manufacturers use the perpetual inventory method to compare inventory averages across different periods. So, what type of systems offer this type of inventory calculations?
Katana ERP is a perpetual inventory management software that uses moving average cost (MAC) to provide you with real-time inventory valuations.
Each time you make a purchase order, the average costs for the items you have in stock are recalculated by adding the cost of the newly acquired items to the cost of items already in stock and dividing that by the number of items in stock. Why is this important? Well, the costs of your raw materials never stay the same price — inflation, bulk discount deals, and shady supplier, a lot of factors will affect the cost of the items you buy.
And Katana helps you by using MAC and automatically recalculating your inventory value for every purchase to get the most accurate inventory valuation.
So, what is Katana ERP software? It’s an all-in-one tool that helps manufacturers with:
Check it out for yourself. Katana offers a 14-day free trial, so you can see firsthand how to calculate average inventory without stress.
We hope that you found this article useful, and if you have any questions, feel free to reach out to us, and we’d be happy to answer them.
And until next time, happy valuating
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