December 10, 2020    < 1 min read

Calculating average inventory is an extremely important part of your overall inventory strategy because it is the basis of knowing how much stock you should have on hand. In this article, we’ll explain the 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.

Businesses need to know the average inventory to calculate the value of inventory in a given time period. It also determines how much inventory they need to hold at any given point in time.

How to calculate average inventory

To calculate the average inventory, simply add the beginning inventory to ending inventory. Then, divide the total by the number of months in the period you’re looking for. The formula is:

Average inventory = (Beginning inventory + Ending inventory) / Months in the period

gaming controls Average inventory values can be used to compare overall sales volume

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) / 3
Average inventory = 3,666

Alice works out that on average, she had 3,666 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 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 — and if not, they can get working on any issues which may be reducing profitability.

Understanding inventory average is also important for making stock orders. If you don’t know what your average inventory is, it can directly impact your future supply. For example, if a business owner was to incorrectly calculate inventory so that it was recorded as being lower than it is in reality, this would skew their understanding of how fast stock was selling. This could negatively influence the next order of stock and they’d be left with excess stock they actually aren’t able to sell.

anticipatory inventory

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.

Average inventory and lead times

Average inventory and lead time go towards helping you decide when you should replenish your stock — that is, your reorder point. This helps you achieve the right balance of stock on hand so you meet demand, keep your customers rolling in, and keep the business profitable.

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 ROI. 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 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.

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