How Is Average Inventory Calculated?
Average inventory is calculated by finding the beginning and ending inventory balances at each period. These balances are summed and then divided by the total number of periods. A safety stock can be calculated as necessary.
- Find the beginning and ending inventory balance for each relevant period
Average inventory is considered over a period of time, and this period can be a span of months or even a year. The beginning and ending inventory balances at each period must be determined to calculate average inventory.
- Sum the inventory balances, and divide by the total number of periods
A person can use either the beginning or ending inventory balances for purposes of the calculation. These balances for each period must be summed and then divided by the total number of periods. For instance, the beginning inventory balances for each month of the year should be summed and then divided by the total months in the year to calculate average monthly inventory.
- Determine a safety stock if necessary
In some cases, an organization may want to carry extra inventory as safety stock. The extra inventory required is calculated as the largest purchase order minus the average monthly inventory. This safety stock ensures that if another significant purchase order comes through, sufficient inventory is on hand to fulfill the order.