Average stock, or average inventory, is equal to stock at the beginning of the period plus stock at the end of the period divided by two. It represents the investment a business has made in its inventory.
Average stock is arrived at using the following formula: Average Stock = (Opening Stock + Closing Stock) / 2.
The figure can be calculated for each class of stock, namely raw materials, work in progress, and finished goods. If a company is dealing with different types of products, it can calculate the average inventory of each one. For example, a company dealing in food items may have separate departments for solid foods, drinks, and food additives.
Reasons for Carrying Stock
The reasons for carrying stock are clear: a good stock base ensures customers receive a wide choice, orders are met more quickly, purchases made in bulk attract better discounts, production planning for larger amounts saves set-up overheads, and so on.
However, having too high an average stock creates disadvantages. For instance, the cost of carrying stock would be high, losses can occur through pilferage, breakage and obsolescence would be high, and the company’s ability to react to changing demand or fashion patterns would be restricted.
If the goods are easily procurable, there is little need to carry a high level of stock. On the other hand, if availability is governed by seasonal fluctuations, having a higher average stock is often prudent and profitable. Therefore, the right balance is integral. Often, the most reliable indicator of the right balance is the industry average.
John Trading Concern has opening stock of $570,000 and closing stock of $630,000 for the year 2016. Calculate the average stock.
Average stock = (570,000 + 630,000)/2
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.