What Is Average Inventory and How Is It Calculated?

Businesses across various industries manage physical goods, known as inventory, which are vital for their operations. Inventory includes raw materials, partially finished products, and completed goods ready for sale. One significant metric used to understand a company’s stock levels is average inventory, which provides a smoothed view of inventory over a period.

Understanding Average Inventory

Average inventory provides a balanced view of stock levels over a specific period. It helps businesses assess their typical inventory holdings, offering a clearer picture than a single snapshot of inventory at a particular moment. This metric is especially valuable because inventory levels can fluctuate significantly due to factors like seasonal demand, large incoming shipments, or sales surges. By averaging inventory over time, businesses can mitigate the impact of these temporary spikes or dips, leading to a more stable and representative indicator of their overall inventory position.

Calculating Average Inventory

Calculating average inventory considers the inventory value at the beginning and end of a specific accounting period. The most common method adds the beginning inventory to the ending inventory and then divides the sum by two. Beginning inventory represents the value of goods on hand at the start of an accounting period. Conversely, ending inventory is the value of unsold goods remaining at the close of the accounting period.

For example, if a business starts a month with $10,000 worth of inventory and ends the same month with $12,000 in inventory, the calculation would be ($10,000 + $12,000) / 2, resulting in an average inventory of $11,000 for that month. While this simple method is widely used, particularly for shorter periods, average inventory can also be calculated over multiple periods, such as a quarter or a year, by summing the inventory values at various points and dividing by the number of data points.

Applying Average Inventory

Average inventory is used to derive other financial metrics. Its most common application is in determining the inventory turnover ratio, which measures how many times a company has sold and replaced its inventory over a specific period. The inventory turnover ratio is calculated by dividing the cost of goods sold (COGS) for a period by the average inventory for the same period. For instance, if a company’s COGS was $55,000 and its average inventory was $11,000, the inventory turnover ratio would be 5, indicating that the company sold and replaced its inventory five times during the period.

Another related metric is “days sales in inventory” (DSI), also known as “days in inventory.” This metric indicates the average number of days it takes for a business to convert its inventory into sales. DSI is often calculated by dividing 365 days by the inventory turnover ratio. These applications of average inventory help businesses assess their efficiency in managing stock and converting it into revenue.