Average Inventory Formula

The average Inventory Formula is used to calculate the mean value of Inventory at a certain point in time by taking the average of the Inventory at the beginning and the end of the accounting period. It helps management 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, Average takes care of such spikes as it takes the mean value of both the Beginning and Ending Inventory.

The above formula is one of the simplest ways to calculate the Average Inventory, which is used to avoid the effect of sharp spikes or drops in the Ending Inventory as it involves taking the 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 optimize its 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 a 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.)

• The average inventory formula calculates the mean inventory value during a specific period by considering the inventory levels at the beginning and end of that period. 
• This calculation enhances management's understanding of the necessary inventory required for seamless daily operations.
• Inventory analysis plays a pivotal role in determining the optimal inventory quantity needed to facilitate sales activities. This involves utilizing the average of both initial and closing inventory levels, a logical approach for evaluating sales performance.
• Overreliance on average inventory as a planning tool in the woolen industry can potentially result in either missed sales opportunities or an excessive inventory burden. 

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

Avg Inventory-

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

#1 - Inventory Turnover Ratio

One of the important ratios uses 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 implies weak sales, excess Inventory, or lack of demand for the company's product.

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:

= ($128000/$16000) = 8

#2 - Avg. Inventory Period

Another important ratio uses the Inventory Turnover Ratio, which allows management to understand the time to convert goods into sales.

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:

= (365/8) = 45.63

You can use the following calculator.

• One of the major issues is that it's calculated based on the Ending Inventory Balance of the period, which may not be a true representative of the period's average.
• 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. It is not a good estimation tool for businesses, which is seasonal as their seasonal shifts impact their sales. Examples include companies in the Woolen Industry etc.
• The majority of the business provides an estimate of the Ending Inventory instead of making an exact Inventory count, which again affects the calculation of Average Inventory, which itself is based on the Mean of Beginning and Ending Inventory.

• Inventory helps analyze how much Inventory Investment is required to support a given level of sales for the business. It is used to measure the amount of Inventory that a 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 on a particular date only. When comparing the business Sales level with its Inventory level, it makes sense to use Avg.
• Inventory becomes more relevant in case of seasonal businesses. To compensate for the increased demand during peak season, it needs to build up more Inventory than the usual Average for the rest of the non-seasonal period.
• 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.

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