Average stock or average inventory is equal to stock at the beginning of the period plus stock at the ending of the period divided by two. It represents the investment a business has made in inventory.
Average stock is arrived at using the following formula:
It can be calculated for each class of stock, namely raw materials, work in progress and finished goods. If a company is dealing in different types of products, it can calculate average inventory of each type of product. For example, a company dealing in food items may have separate departments for solid foods, drinks and food additives. They may be preparing separate trading account for each of these departments; hence they need to calculate average stock held in each department to effectively control it.
Reasons for carrying stock
Reasons for carrying stock are obvious: a good stock base ensures that customers are given a wide enough choice, orders are met more quickly, purchases made in larger quantities attract better discounts, production planning for larger quantities is easier and saves set-up overheads, etc. However, having too high an average stock would have certain disadvantages, like cost of carrying stock would be high, losses through pilferege, breakage and obsolescence would be high, and the company’s ability to react to changing demand or fashion patterns would be restricted. Again, if the goods are easily procurable there is little need of carrying a high level of stock. On the other hand, if availability of stock is governed by seasonal fluctuations, having a higher average stock is often prudent and profitable. Having the right balance is therefore important. Often the most reliable indicator of the right balance is industry average.
John Trading Concern has opening stock of 570,000 and closing stock of 630,000 for the year 2016. Calculate average stock.
Average stock = (570,000 + 630,000)/2