How can you determine the average stock level
Definition: Average inventory
The average inventory (otherwise: average storage duration) informs the entrepreneur about the amount of materials and goods that are on average in the warehouse. In addition to the other entrepreneurial tasks, this area is also of particular importance, as high inventories cause high capital tie-up costs. This affects the company's liquidity. To avoid this, the company determines the average inventory in terms of value, pieces or another unit of measure.
How does the company determine the average inventory level?
In order to obtain the most accurate value possible for the inventory, it is advisable to carry out the average value on the basis of the annual or monthly inventory. In addition, the average inventory can also be calculated using the minimum inventory.
Determination of the average inventory based on the annual inventory
The determination of the inventory on the basis of the annual inventory is based on the values of the previous year's balance sheet and the current bookkeeping. Due to the material balance sheet continuity, the inventory of the previous year is identical to the initial inventory of the current year. The second quantity that the company needs for the determination is the stock level at the end of the current period. The entrepreneur receives this from the current bookkeeping. With these two key figures, the company can calculate the average inventory based on the annual inventory as follows:
Average inventory = (start value of inventory + end value of inventory) / 2
A textile company makes shirts and pants. In the previous year's balance sheet, the inventory shows a value of 120,000 euros. At the end of the current year, the current bookkeeping results in a value of 160,000 euros.
The previous year's value of the inventory of 120,000 EUR is identical to the initial inventory of the current year. The determination of the average inventory based on the annual inventory brings the following result:
Average inventory = (120,000 euros + 160,000 euros) / 2 = 140,000 euros
Determination of the average inventory based on the monthly inventory
When determining the inventory on the basis of the monthly inventory, the inventory of each month is taken into account. The starting point here - as with the determination of the stock on the basis of the annual inventory - is the stock at the beginning of the year.
The formula for determining the average inventory based on the monthly inventory is:
Average inventory = (inventory at the beginning of the year + 12 monthly inventory) / 13
A manufacturing company started business operations on August 1st, 2019. The initial stock of 10,000 euros results from the contributions of the shareholders. The following values are determined for the months of September to December 2019:
- September 2019: 8,000 euros
- October 2019: 9,000 euros
- November 2019: 11,000 euros
- December 2019: 10,200 euros
The average inventory is determined as follows:
Average inventory = (10,000 euros + 8,000 euros + 9,000 euros + 11,000 euros + 10,200 euros) / 5 = 9,640 euros
Calculate inventory with minimum inventory
The minimum stock (also safety stock or iron reserve) is the stock that a company should always keep in stock in order to avoid production disruptions. If a certain material is no longer available in the warehouse, production must be stopped. This can lead to contractually agreed appointments with business partners or customers not being kept. The consequences are the payment of interest on arrears or the loss of important customers. For this reason, the company determines a safety stock. This ensures that all materials that the company needs for a production process are in stock. The company also uses safety stock to determine average inventory levels. The formula for determining the average stock level with the safety stock is:
Average stock level = safety stock + (optimal order quantity / 2)
The optimal order quantity gives the entrepreneur the storage quantity that does not result in high storage and procurement costs. When purchasing raw materials, the company's purchaser also pays attention to the profitability of the investment.
A company makes furniture out of wood. The company keeps the materials used in stock until the start of the manufacturing process. The safety stock is 4,000 pieces. The company has determined the optimal order quantity with 2,500 pieces. The company values the stocks at the purchase cost of EUR 3.50 per item.
Based on the figures given, the average inventory is calculated as follows:
Average inventory = 4,000 pieces + (2,500 pieces / 2) = 5,250 pieces
The average stock is valued at the purchase price:
5,250 pieces x 3.50 euros = 18,375 euros
How can the average inventory be reduced?
In order to ensure the company's liquidity, a company must be as cost-effective as possible. The measures also include economical management of the warehouse accounting. Storage costs can be reduced, for example, by the company acting on the average inventory. In particular, the following strategies will help the company to optimize its average inventory:
- The company plans the capacities required for the production process.
- Better inventory management - and thus also an optimal average inventory - can be achieved if the company uses inventory control systems to support it.
- The company sets a safety stock.
- The company opts for just-in-time production.
What are the warehouse key figures?
In addition to the average inventory, the following inventory key figures provide information about the profitability of inventory accounting:
- Inventory turnover
- Average storage time
- Storage interest
- Cost of goods
The determination of the inventory turnover rate
With the help of the inventory turnover rate, the company can determine for a certain period of time - e.g. the fiscal year - how often it has used up the entire inventory and replaced it with new goods and materials. If the inventory turnover rate is high, the company incurs only low capital tie-up costs. A company achieves this goal, for example, by introducing just-in-time productions or by shortening the ordering periods.
To determine the inventory turnover rate, the company divides the average inventory at purchase prices by the cost of goods.
What does the average storage period say?
The entrepreneur uses the average storage time to determine how long goods and materials remain in the warehouse on average. In addition to the conditions on the markets (sales market and procurement market), the key figure also depends on the company's warehouse policy. It is determined by multiplying the average inventory by 360 days.
How is storage interest calculated?
Every storage location costs the company money. The goods and materials kept in stock tie up capital. As a result, the company misses out on interest income that it would have earned if another form of investment had been chosen. The company uses the inventory interest to determine how high the loss of interest is. The storage interest is not an expense that the company actually incurs. These are imputed costs that the company only uses for internal billing. The storage interest is calculated using the following formula:
Storage interest = (storage interest rate x average storage duration x cost price) / 100
The calculation of the cost of goods
The cost of goods indicates the amount of goods the company consumed or delivered to customers in a fiscal year. It uses the following formula to determine the cost of goods:
Cost of goods = beginning of year inventory + stock receipt - end of year inventory
- The average inventory indicates the average amount of goods and materials in the warehouse.
- Since a long storage period is associated with high capital tie-up costs, the average stock in the warehouse should be designed as optimally as possible.
- A distinction can be made between three calculation methods for determining the warehouse key figure.
- If the entrepreneur determines the inventory on the basis of the annual inventory, the result of the beginning of the year and the end of the year is divided by two.
- When calculating the stock on the basis of the monthly values, the entrepreneur calculates a sum from all stocks at the beginning of the month. He divides this sum by the number 13.
- Alternatively, the safety stock and the optimal order quantity can be taken into account when determining.
- In order to ensure liquidity and profitability, the company is developing measures that are intended to help reduce average inventories.
- In addition to defining a safety stock, the key figure can also be reduced through just-in-time production.
- Further inventory key figures are the inventory turnover rate, the cost of goods, the storage interest and the average storage duration.
- The use of inventory key figures helps a company to act economically and not run into liquidity bottlenecks.
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