Mastering Average Inventory Calculation in Manufacturing

Is your manufacturing company having a tough time keeping inventory under control? If so, regularly tracking your average inventory can help.

Calculating your average (mean) inventory allows you to see how much of your inventory you’ve gone through during a specific period.

Knowing that number gives you a better grasp of your supply chain, manufacturing processes, and sales teams’ efficiency in meeting your goals.

When you learn how to calculate average inventory, you’ll optimize your inventory management and get better control of your stock. More importantly, it will help you plan for a sound financial future.

Average Inventory Formula

The average inventory formula is simple. It’s the mean inventory value over a given period.

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

Read on to learn more about this key component of capacity planning.

What Is Average Inventory?

Your company’s inventory is the value of all the products and raw materials you have on hand. The average inventory is the mean value of those things between two or more periods.

How to Calculate Average Inventory: An Example

If you want to track your mean inventory over a year, you could start by taking a monthly inventory on the same day each month. That approach will give you a more accurate picture, especially if your inventory fluctuates seasonally.

Here’s an example of how to calculate this metric each month. Begin by counting your current inventory. Let’s say you take your first inventory on the first day of May.

Then, you count the inventory at the end of May. Divide by two, and you’ll have the average inventory that month.

Why Calculating Average Inventory Matters

The average inventory is one of the metrics you use to calculate your inventory turnover. Measuring your inventory turnover is critical for helping you increase your turnover rate.

An increase in your inventory turnover rate means your company is turning more raw materials into finished products. It also means you’re turning those products into more sales.

The inventory turnover rate, then, measures how efficient your processes are. It helps you see where you can improve every step of the process.

Calculating your average inventory can unlock those insights. The more effective your inventory management is, the more efficient your business is.

Why Is Average Inventory Critical in Manufacturing?

Manufacturing is an industry where inventory involves both raw materials and finished products. Finding the right materials in the amount you need and getting them to your facility on time is critical for the entire manufacturing cycle.

Turning those materials into their final form quickly and efficiently is a must in the manufacturing space. Measuring the value of both elements over time gives you a snapshot of your company’s performance.

Here are some of the specific ways this measurement can make your company more efficient.

Improves Stock Management Processes and Cuts Waste

Tracking your mean inventory helps you improve your stock management processes. An accurate measurement can help you reduce waste.

Enhances Production Planning and Prevents Shortages

This key metric will show how efficiently you turn those raw materials into finished products. Thus, it can help you refine your production planning and prevent shortages.

Shortages can occur from defective products or slow production methods. Keeping track of your mean inventory can help you detect factors that lead to those shortages.

Optimizes Cash Flow and Streamlines Financial Planning

Knowing your inventory over time can help you better manage your cash flow. Having enough cash to purchase raw materials ahead of peak demand is crucial.

More importantly, it can help you with long-term financial planning. Knowing when to set money aside for future use and when to pull it out is critical to an effective plan. Measuring inventory over time can give you that knowledge.

Supports Accurate Demand Forecasting

Forecasting demand through the power of AI isn’t magic. You need accurate numbers to ensure your AI tool spits out an accurate forecast.

Conducting average inventory calculations can produce the metrics your AI tool needs.

How to Calculate Average Inventory

Let’s take a deeper look at the average inventory formula. Note that it uses “beginning inventory” and “ending inventory.”

• Beginning Inventory
  Your beginning inventory is the value of your raw materials and stock at the start of the period you want to average. 
• Ending Inventory
  Your ending inventory is the value of your raw materials and stock at the beginning of the period.  
• Average Inventory
  (Beginning Inventory + Ending Inventory) / 2
  To calculate the average of more than two periods, average each period. Add the averages of each of the periods. Then divide by the number of periods you want to analyze.
• Apply the Average Inventory Formula
  Let’s say you want to find your average inventory over a month. Your beginning inventory for that month was $2,000, and your ending inventory was $1,000. Here are the steps:

1. ($2,000 + $1,000) = $3,000
2. $3,000 / 2 = $1,500 = your average inventory during that month

Step-by-Step Guide to Calculating Average Inventory

Conducting your average inventory calculation is easy when you take it one step at a time. Start with the beginning inventory count on the first day of each period you want to average.

First, Find the Beginning Inventory Count

Usually, you can find your beginning inventory in your inventory management system. Your accounting records should have the number. If you don’t have it, you’ll need these metrics:

• Cost of goods sold: This number represents the costs you’ve paid to produce the products you’ve sold. Include what you’ve paid for the labor, materials, and other production costs. It does not include marketing, sales, or shipping to customers.
• The previous period’s ending inventory: Use the count you took at the end of the last period.
• Inventory purchases: This metric is the value of new inventory. It would include raw materials or other assets you bought the last month.

Then, apply the following formula to find the current period’s beginning inventory:

(COGS + Ending Inventory) – Inventory Purchases = Beginning Inventory

Next, Calculate the Ending Inventory

To find the ending inventory, you’ll need the following numbers:

• The inventory count at the beginning of the period
• Any purchases of new assets or raw materials you’ve added to your inventory during the period
• The cost of the goods you’ve sold during the period

Then, apply the ending inventory formula:

Beginning Inventory + Inventory Purchases – Cost of Goods Sold = Ending Inventory

Find Your Average Inventory: An Example

Let’s look at how these numbers factor into a real-life scenario.

Suppose you manufacture handbags and want to find the average inventory during the holiday shopping season. That would include the three months preceding the holidays — October, November, and December.

You discover that in September, you’ve spent $10,000 making your handbags. At the end of September, your inventory was $100,000, and you purchased $10,000 of materials and other assets.

Find the beginning inventory

Using the beginning inventory formula, plug in the following numbers:

($10,000 + $100,000) – $10,000 = $100,000 = October’s beginning inventory

Find the ending inventory

Then, at the end of October, calculate your ending inventory.

You started the season with $100,000 in inventory. Then, you purchased $20,000 of inventory to meet the demand. The cost of the goods sold was $30,000.

Plug in the numbers like this:

$100,000 + $20,000 – $30,000 = $90,000 = October’s ending inventory

Finally, calculate your mean (average) inventory

Then, enter those values into the mean inventory formula:

($100,000 + $90,000) / 2 = $95,000 = October’s mean inventory

You follow the same procedure for November and December. You find:

• November’s average was $80,000
• December’s average was $70,000

Then add the three months’ averages and divide by three:

($95,000 + $80,000 + $70,000) / 3 = $81,667 (rounded to the nearest dollar) = Your holiday season average inventory

Knowing your average can help you better manage your inventory levels. It’s critical during peak seasons. Also, you need it to calculate other key metrics, such as the inventory turnover ratio.

Common Mistakes to Avoid When Calculating Average Inventory

When taking inventory, mistakes often happen. Here are some of the most common ones:

Failing to Calculate Beginning Inventory on the Same Day

It’s hard to get an accurate read if you calculate your beginning inventory on different days of the week or month. Stay consistent to ensure you compare the same unit of time each time you calculate.

Neglecting Seasonal Variations

Many manufacturers deal with seasonal stock and sales fluctuations. Cars, swimwear, gift items, school supplies — all are items whose sales vary with the season.

Suppose your calculations fail to consider seasonal variations. In that case, you might fall short of inventory when you need a ton of stock.

Using Estimated Rather than Physical Counts

During busy seasons, it’s tempting to eyeball your stock and estimate how much you have. However, doing so could lead to inventory overage.

Instead, take the time to do physical counts to avoid such situations.

Hiding Stock to Manipulate the Numbers

The adage “a place for everything and everything in its place” applies double in manufacturing applications. Storing overstocked products in out-of-the-way places to avoid inventory counts could lower your average inventory below its actual number.

Avoid the temptation to manipulate your inventory by failing to count actual inventory. It can harm your company’s bottom line in the long run.

How to Use Average Inventory for Better Inventory Management

Keeping track of your average inventory can help you avoid having more stock than you can sell. It can also keep you from running out of products during peak seasons. Regularly calculating it can help you reduce storage costs for stock you don’t need too.

1. Optimize Your Cash Flow
   Tracking your mean inventory numbers allows you to take better control of your cash flow. 
   Knowing when to limit buying stock ensures you’ll have enough cash to make more products when needed.  
2. Know When to Order
   Learning when to order new raw materials is easier when you keep track of your inventory over time. Better inventory management keeps your customers happy by having what they need when they need it.
3. Identify Slow-Moving Stock
   Whether it’s the time of the year or a product that isn’t in demand anymore, you must uncover why your stock isn’t selling. Comparing your average against current numbers alerts you to look for the cause — and fix it.
4. Learn When Demand Trends Occur
   In manufacturing, you need to align your production schedule with customer demand. Looking at your mean inventory over time can help you learn when demand will rise. Then, you can adjust your production to meet that increase.
5. Forecast Storage and Capital Needs
   Discovering when you’ll need more capital or storage is easier when you regularly measure your average inventory.

Average Inventory FAQs

What is the formula for average inventory with EOQ?

The economic order quantity (EOQ) equation allows manufacturers to calculate the best quantity to order. Using this formula helps you lower inventory costs by balancing orders and inventory.

Let D = your annual unit demand

Let S = the cost per purchase order

Let H = the cost to hold one unit per year

Plug those numbers into the following equation: √(2DS/H). The result will be the EOQ.

How can I calculate the average inventory in Excel?

First, find the beginning and ending inventory for the period you want to average.

Next, create a new Excel spreadsheet. Label each column thus:

“Beginning Inventory”

“Ending Inventory”

“Average Inventory”

Enter the numerical value for your beginning and ending inventory under their column headings.

Now, click on the cell below the “Average Inventory” heading. Click “Insert Function.”

Then, enter the cell numbers for the beginning and ending inventory. The resulting number will be the mean inventory value. Since finding the average is a linear process, it is easy to calculate it with Excel.

What are the key metrics derived from average inventory?

You can derive a wealth of helpful metrics by using this basic calculation. These numbers include:

• • • • • The inventory turnover rate
        • The days sales of inventory
        • The stock-to-sales ratio

What are the limitations of average inventory?

While useful, the mean inventory has its limits. Seasonal variations, variances in economic cycles, and specific product performance need a deeper dive.

What is the inventory turnover ratio?

The inventory turnover ratio shows how often a business turns over its inventory during a specific period. It helps companies learn more about their performance, including:

• • • • • The average number of days it takes for them to sell their inventories
        • How to make more efficient decisions about manufacturing processes, purchasing, pricing, and marketing

The formula to calculate the inventory turnover ratio is:

Inventory Turnover Ratio = COGS / Average Inventory Value

Who should calculate the average inventory?

The person you choose to calculate this metric could depend on the size of your business. Larger companies delegate the task to an employee. Usually, an inventory manager handles the calculation. Small business owners often calculate the mean inventory themselves.

Software solutions designed for manufacturing companies can streamline the process. They are your “easy” button at inventory time, saving you time and money.

Conclusion

Mastering average inventory calculation gives you a snapshot of how your business has performed over time. Regularly monitoring it can spell success for your manufacturing plant.

Furthermore, this formula is a vital ingredient in discovering more critical metrics. Those metrics can dig deeper into some details that an average inventory might miss.

Manufacturers are especially vulnerable to seasonal variations, economic uncertainties, and material shortages. Knowing how to use key metrics to make better decisions can take your company from surviving to thriving.

With inventory software geared to your needs, you’ll spend less time accounting and more time honing your processes.