Inventory is an important account to keep accurate on a company's financial statements. The average inventory is used in several financial ratios, such as the Cost Of Goods Sold. Analysts base part of their analysis on a company by using these financial ratios, which makes the need for accurate inventory volume information significant for investors.
Choose the method for calculating the inventory on the Balance Sheet and Income Statement. There are two methods that can be used for this. The first is to take note of the inventory at the beginning of the year and the end of the year. The other is to keep a monthly total of inventory at the end of the year.
Calculate the average inventory based on starting and ending inventory. Note the value of your inventory on the first date of the year and on the last date of the year. Add these totals together and divide by two. The result will be the average inventory for the year. This is the first method that you can use, and works well for companies with very little fluctuation in inventory during the year.
Track the value of inventory on the last day of each month if you are using the monthly total method to calculate your average inventory. Your first measurement will be the first of the year, and then each month it will be the last day of the month. This is the first step of a second method, which is a better representation of average inventory for companies with significant fluctuation in inventory from month to month.
Add the totals that you recorded in Step 3. Divide this total by 13. The result of this calculation is your average inventory.
If your inventory fluctuates significantly during the year, the monthly recording method of measuring your average inventory can give you the most accurate total. If your inventory total has very few fluctuations, calculating it based on beginning and ending inventory for the year should be accurate.
The reason the total is divided by 13 in Step 4 is there is one measurement at the end of each month, plus your starting inventory, which was the measurement on the first day of the year.
If you change your method you account for average inventory from one year to the next, this must be noted on your Balance Sheet and other Financial Statements so investors are aware the change could be based on the method used along with changes in inventory volume.