WallStreetMojo

WallStreetMojo

WallStreetMojo

MENUMENU
  • Free Tutorials
  • Certification Courses
  • 250+ Courses All In One Bundle
  • Login
Home » Accounting Tutorials » Assets Tutorials » Average Inventory Formula

Average Inventory Formula

Formula to Calculate Average Inventory

Average Inventory Formula is used to calculate the mean value of Inventory at a certain point of time by taking the average of the Inventory at the beginning and at the end of the accounting period. It helps management to understand the Inventory, the business needs to hold during its daily course of business.

Since Ending Inventory can be impacted by a sudden drawdown of Inventory or a large supply of Inventory, therefore Average takes care of such spikes as it takes the mean value of both the Beginning and Ending Inventory.

Average Inventory = (Beginning Inventory + Ending Inventory) / 2

Average-Inventory-formula

The above formula is one of the simplest ways for the calculation of the Average Inventory, which is used to avoid the effect of sharp spikes or drops in the Ending Inventory as it involves taking Average of Beginning and Ending Inventory.

Inventory is the driving force behind the ability of a business to generate revenues and resulting profit, and managing Inventory cost-effectively helps the business to optimize their profits. It acts as a comparison tool and helps in analyzing overall Revenue generated by the business from the context of Inventory utilization (Holding Inventory for long also results in a cost for the business in the form of storage cost, labor cost and also the business carries the risk arising on account of Inventory becoming obsolete, rotted, etc.)

Example (with Excel Template)

You can download this Average Inventory Formula Excel Template here – Average Inventory Formula Excel Template

ABC Limited reported the following details on its Inventory levels as on 31.03.2018.

Popular Course in this category
Sale
All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)
4.9 (1,067 ratings)
250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion
View Course

example1.1

example1.2

Avg Inventory-

average inventory example

Use and Relevance

Inventory Analysis helps management to understand its Purchase pattern and Sales trend, which helps them in better planning of Inventory to avoid the problem of stock-outs and also to avoid the cost of carrying excess Inventory as that can result in strain on the finances of the company. Further. It helps in the computation of various useful ratios, namely:

#1 – Inventory Turnover Ratio

One of the important ratios which use Avg Inventory to understand how fast a company sells its Inventory whereby a higher ratio implies either strong sales or insufficient Inventory resulting in loss of business and a lower ratio implying weak sales, excess Inventory, or lack of demand for the company’s product.

Inventory Turnover Ratio= (Cost of Goods Sold/Avg Inventory)
Example of Inventory Turnover Ratio

Continuing with the above-given example, let’s assume ABC Limited made a $200000 in Sales and $128000 in Cost of goods sold (COGS). Using the data, we can compute the Inventory Turnover Ratio as follows:

inventory turnover ratio example

= ($128000/$16000) = 8

#2 – Avg. Inventory Period

Another important ratio that makes use of Inventory Turnover Ratio and allows management to understand the time taken in converting goods into sales.

Avg Inventory Period = (Number of Days in Period/Inventory Turnover Ratio)
Example of Avg Inventory Period

Continuing with an above-given example where ABC limited has an Inventory Turnover Ratio of 8 times. Using the data and assuming 365 days, we can calculate the avg Inventory Period as follows:

average inventory period

= (365/8) = 45.63

Average Inventory Calculator

You can use the following calculator.

Beginning Inventory
Ending Inventory
Average Inventory Formula =
 

Average Inventory Formula =
Beginning Inventory + Ending Inventory
=
2
0 + 0
=
2

Issues with Average Inventory Formula

  • One of the major issues is it’s calculated based on Ending Inventory Balance of the period, which may not be a true representative of the Average of the period.
  • It is not a good estimation tool for business, which is seasonal as their seasonal shifts impact their sales. Any Inventory planning based on Avg Inventory will result in loss of sales during peak season time and excess Inventory during the non-peak period. Examples include companies in Woolen Industry etc.
  • The majority of the business provides an estimate of the Ending Inventory instead of making an exact Inventory count, which again results in affecting the calculation of Average Inventory, which itself is based on the Mean of Beginning and Ending Inventory.

Final Thoughts

  • It is used to measure the amount of Inventory which business usually holds over a longer time frame. It is simply the average between the Inventory level reported during the Beginning of the measurement period and the end of the measurement period.  It holds relevance as the Income Statement (covers a period of time), and the Balance Sheet represents the position as on a particular date only. As such, when comparing the business Sales level with its Inventory level, it makes sense to use Avg. Inventory helps in analyzing how much Inventory Investment is required to support a given level of sales for the business.
  • Inventory becomes more relevant in case of businesses that are seasonal and needs to build up more Inventory than the usual Average of the rest of the non-seasonal period to make up for the increased demand during peak season.
  • Inventory Holding provides various exciting insights into the performance of a company and the movement of Inventory in and out of business, which can further dwell into by the management to make better-informed business decisions.

Recommended Articles

This article has been a guide to the Average Inventory Formula. Here we learn how to calculate Average Inventory using its formula along with its uses, practical examples, and calculator. You can learn more about Accounting from the following articles –

  • Average Formula in Excel
  • Average Formula
  • FIFO Method of Inventory Valuation
  • Top Types of Inventory
1 Shares
Share
Tweet
Share
Primary Sidebar
Footer
COMPANY
About
Reviews
Contact
Privacy
Terms of Service
RESOURCES
Blog
Free Courses
Free Tutorials
Investment Banking Tutorials
Financial Modeling Tutorials
Excel Tutorials
Accounting Tutorials
Financial Statement Analysis
COURSES
All Courses
Financial Analyst All in One Course
Investment Banking Course
Financial Modeling Course
Private Equity Course
Venture Capital Course
Excel All in One Course

Copyright © 2021. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. CFA® And Chartered Financial Analyst® Are Registered Trademarks Owned By CFA Institute.
Return to top

WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Book Your One Instructor : One Learner Free Class
Let’s Get Started
Please select the batch
Saturday - Sunday 9 am IST to 5 pm IST
Saturday - Sunday 9 am IST to 5 pm IST

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Login

Forgot Password?

WallStreetMojo

Free Accounting Course

You will Learn Basics of Accounting in Just 1 Hour, Guaranteed!

* Please provide your correct email id. Login details for this Free course will be emailed to you

WallStreetMojo

Download Average Inventory Formula Excel Template

New Year Offer - All in One Financial Analyst Bundle (250+ Courses, 40+ Projects) View More