Accounting for inventory is on the mind of any business focused on its supply chain. Manufacturers and retailers alike know the value of seasonal forecasting in their inventory management, but no matter how accurately they predict demand, many businesses deal with material loss from spoilage, canceled orders from stock outs, and high storage costs from overstock.
Average inventory accounting helps businesses balance each month despite large shipments going in and out as demand changes. It solves many of the faulty assumptions that businesses make when they base their inventory estimates on current stock or a specific accounting period.
The bottom line is that inventory management systems equipped with average inventory accounting offer a broader picture that results in more accurate month-to-month inventory estimates than conventional methods can achieve.
What is average inventory accounting?
Average inventory takes an inventory estimate (including raw materials or products, depending on the business’s industry) and expands its scope to estimate the value of that inventory over time. Normal inventory accounting only focuses on the products the business currently has on hand to sell to customers or the materials that are ready for manufacturing.
The problem with accounting for inventory using end-of-month totals is that these totals vary widely based on shipment schedules and changes in demand. If you take inventory during a seasonal buying surge, for instance, your numbers would suggest that you need to replenish your stock more than you may need to. Or if you do it right after your big shipment arrives for the season, your numbers will still be detrimentally off.
By contrast, tracking inventory using the average over several accounting periods treats a business’s stock as it is.
The benefits of average inventory accounting
It’s one thing to know how to calculate average inventory and another to know what businesses should do with the figures to improve their supply chains.
Average inventory accounting can be used to compare data sets to learn more useful information about your supply chain than one set can communicate alone. For example, consider the cost of inventory shrinkage, inventory damage, and unforeseen events like fire or theft. To accurately calculate these losses, the average inventory for that accounting period is far more useful than a single end-of-month total. The average can be more easily compared to your sales volume for that period to quantify the losses.
Your average inventory is like a big-picture view of your activity for that period. It’s key to calculating your inventory turnover ratio too because inventory accounting from a single point in time is too inaccurate. The average should be the number that gets prioritized when you strategically order stock for the next accounting period.
The takeaway for businesses
Accounting for inventory using the average avoids the pitfalls of inaccuracy that many businesses fall into when they treat their inventory at one time as representing their inventory at any time. As any business knows, the bigger picture is needed to make sense of it all.
To make accounting for inventory more viable, many businesses are turning to workforce analytics software to help calculate the averages and manage the data. The numbers may be useful but can only provide effective strategies for inventory management when they are consistently free of human error and integrated into all of a modern business’s management systems.