Average Inventory- Meaning and Calculation

Proper inventory stock management is essential for handling costs and enhancing customer experience. While excessive inventory indicates uncertainty and unnecessary capital blockage, you risk losing out on sales and opportunities with an insufficient inventory. Maintaining the correct inventory quantity is necessary for growing your business and managing aspects like operating costs, customer satisfaction, and sales.

What is the Average Inventory?

Inventory refers to the number of saleable products in hand or the quantity of raw material for manufacturing products. Average inventory is an approximate or estimated calculation of the quantity of inventory a company possesses over a specific period. Receivement of oversized shipments, a spike in sales, etc., can cause changes in the inventory balances at the month-end, as they replenish or deplete the inventory. Calculating the average inventory uniforms the surge on either side and provides a more reliable index of inventory availability.

Why is Average Inventory Important?

Several factors can cause fluctuations in inventory stock. While a large delivery can cause a spike in your inventory stock, a sale surge during a peak season can deplete your inventory. Fluctuations are especially evident in seasonal businesses. However, these factors are temporary, and you cannot depend on these temporary factors for deciding your inventory stock. This is why average inventory is important. 

• Average inventory helps you strategically plan the quantity of stock you need to order for your business. 
• It also helps track any loss of inventory due to inaccuracy, expiry, shrinkage, theft, or accidents. 
• The inventory turnover ratio and the average inventory period can be of immense help in identifying and evaluating the period taken by your company to sell the inventory stock. 

Average Inventory Formula and Calculations

The average inventory formula is usually used for calculating the amount of inventory stock for two accounting periods. However, you can always increase or decrease the period using the same formula. You can increase the period by simply adding the inventory recorded at the end of every month in a year and dividing it by 12. Similarly, for shortening the time duration, you can add the inventory recorded at the starting of the month with the inventory recorded at the end of the month and simply divide it by 2.

Average Inventory = (Current Inventory + Previous Inventory) / Number of Periods

A company can use the average inventory formula to calculate the following ratios-

• Inventory Turnover Ratio

Inventory Turnover Ratio reveals the rate at which a company has sold or restored stock within a given time frame. A high inventory ratio indicates the company’s success in selling the inventory stock and vice versa.

Inventory Stock = Cost of Goods Sold / Average Inventory

• Average Inventory Period

The average inventory period differs across companies and products. It is used for calculating the period required for a company to sell out the inventory stock.

Average Inventory Period = No. of Days in Period / Inventory Turnover Ratio

Example of Average Inventory

Consider that a furniture company has a current inventory stock worth Rs.10,00,000. This is by the inventory stock of the previous three months worth Rs.7,00,000, Rs.5,00,000, and Rs.6,00,000, respectively. So, the average inventory for the furniture company will be calculated in the following manner-
Average Inventory = (10,00000 + 7,00000 + 5,00000 + 6,00000) / 4 = Rs.7,00,000