The average inventory formula is: Average inventory = (Beginning inventory + Ending inventory) / 2.
However there’s more to it than simply knowing the formula. Calculating average inventory is an important part of your overall inventory strategy. In this article, we’ll explain average inventory and show you how to calculate it with examples. We’ll also shed some light on Economic Order Quantity and average inventory days.
What is average inventory?
Average inventory is the average amount of inventory available in stock over a specified period. This tends to be done by month, but it can vary depending on the business model, industry, and other variables.
In inventory accounting you need to know the average inventory to calculate the value of inventory in a given time period.
How to calculate average inventory
To calculate average inventory, simply add the beginning inventory to ending inventory. Then, divide the total by two. The formula is:
Average inventory = (Beginning inventory + Ending inventory) / 2
You can also get a more nuanced measure of your average inventory by adding the total inventory over multiple time periods (e.g. months), then dividing by the total number of periods measured. For example:
(Month 1 + Month 2 + Month 3) / 3
Example: Calculating average inventory
Alice runs a tech store and her gaming devices have been selling really well in the past quarter. She wants to know on average how many gaming devices she had in stock in the last quarter.
She started the quarter with 10,500 units and ended the quarter with 500 units. Here’s how she’d work out average inventory:
Average inventory = (Beginning inventory + Ending inventory) / Months in the period
Average inventory = (10,500 + 500) / 2
Average inventory = 5,500
Alice works out that on average, she had 5,500 units in stock during the last quarter.
Why is it important to know average inventory?
Understanding your average inventory will ensure you’re fully informed about how fast your inventory sells, and what inventory you typically have on hand at any one time.
Inventory managers and business owners should regularly calculate their average inventory to ensure sales are going as planned.
By calculating your average inventory – as well as the average inventory value – you can then go on to calculate your average inventory turnover, a critical ratio that reveals how fast or slow your inventory moves in a given period.
Who should calculate average inventory?
For larger businesses, the task of calculating average inventory usually falls to the inventory manager, who could also be responsible for stocktaking. However, many smaller businesses don’t have the resource to dedicate to staffing an inventory manager.
It’s perfectly fine for a business owner to manage this procedure themselves via manual processes, but as the business grows, this becomes less sustainable. We would always suggest that business owners use a reliable form of inventory software to calculate average inventory, rather than on pen and paper or Excel spreadsheet. Inventory management software can make the process of calculating average inventory super easy, automatic and it’s much less prone to inaccuracies.
For example, you can use barcode scanners and barcodes to help automate the process of counting stock. With every scan, the information about each item will be stored in your database, and when it comes to calculating average inventory, all the detail you need will be just a click away. This is especially useful for businesses carrying large amounts of inventory, or businesses that hold inventory in multiple stores, warehouses or storage units.
Do you need to know the average inventory for every SKU?
While it would be amazing if you had the average inventory for every single product on your shelves, it’s probably not quite feasible, especially as your business starts to grow. Focus on the items which you simply cannot afford to run short of — that is, your most popular and in-demand items.
Review your product line to identify which items you really need to track in terms of average inventory, lead time and ROIC. By focussing just on these most important items, you’ll avoid running out of popular products that keep your customers coming back for more and keep your profit going up.
The limitations of average inventory
Seasonal variance causes inaccuracies
Some products might only sell seasonally — think Christmas goods or Halloween decorations — and businesses will have unusually low inventory balances at the end of the sales season and a jump in inventory balances before the start of the next season.
Different business environments
Another variable when it comes to this calculation is the industry in which your business is operating, the state of the economy, what competitors are doing and more. Businesses should take all of these variables into account when using average inventory to inform any business decisions.
What is Economic Order Quantity?
The economic order quantity is the optimal order quantity taking into account total inventory costs including ordering, receiving and holding. EOQ is a similar concept to the reorder point but it takes into account inventory costs.
The formula to calculate EOQ is:
Economic Order Quantity = √(2DS/H)
Where D is the annual demand in units, S is the ordering cost per purchase order, and H is the holding cost per unit per year.
Assumptions of the EOQ model
The EOQ formula is based on a few assumptions:
- Ordering cost is always the same
- Purchase price is always the same
- Demand and lead time remain constant
- Order costs don’t change depending on size of the order
- Holding costs are reliant on average inventory
- You’re only calculating for one product
How to calculate EOQ
John runs a men’s clothing store. He sells 200,000 shirts a year. His order cost is $1000 per purchase order and his holding cost is $16 per shirt. He wants to know what’s the optimal order quantity. Using the EOQ formula, he calculates he needs to have 5000 units:
EOQ = √(2DS/H)
EOQ = √((2 x 200,000 x 1000) / 16)
EOQ = 5000
The relationship between average inventory and Economic Order Quantity
While you don’t use the average inventory figure to directly calculate EOQ, your holding costs depend on average inventory.
Large orders have lower ordering costs because fewer orders are made in the year, but it results in higher holding costs because there is more stock to store.
Smaller orders have higher ordering costs because the average inventory is low so you need to replenish stock more frequently. However, holding costs are low because of low average inventory levels.
How do you calculate average inventory days?
Average inventory days, also known as days inventory outstanding, is the number of days, on average, it takes for stock to turn into sales.
You can calculate your businesses average inventory days by flowing the below formula:
Average inventory days (DIO) = (Cost of average inventory / COGS) x 365
There’s no perfect number. The average inventory days depends on factors such as what industry you’re in, what you’re selling, your business model and more. Generally a low DIO figure indicates better inventory management.
Calculating average inventory is part of your day-to-day business and especially crucial when it comes time to building inventory reports. Inventory management software tracks sales and turnover rates, making calculations and reporting a breeze.