Average Inventory

What is inventory? Well, it’s just stuff you have for sale...in one form or another.

An auto dealer? All those cars sitting out there in the sun as dive bombing targets for the birds...yep, they’re inventory to the car dealership. The loads of nose hair trimmers sitting on the shelves at The Well Appointed Nostril? Yep, they’re inventory...albeit gross-ish inventory (especially after use). The 4,000 yards of denim cloth sitting in the weaving factory waiting for 13-year-old girls in Thailand to weave all together to make Levi’s for The Gap? Yep, that cloth is inventory (it isn’t finished inventory...it’s just a work in process).

All this inventory is an asset for the company who owns it, and is held as inventory...a work in process on that side of the balance sheet. Right there. And when it’s sold and turned into revenues, it’ll just become part of the expenses line on the income statement, usually as COGS or cost of goods sold.

So what are average inventories?

Well, inventory changes all the time, or at least the dollar value of the inventory at your little company, MoreOnTop Inc. So if you sell gallon jugs of BaldSpotKiller, some days you'll have 5,038 jugs. Then you sell a hundred, leaving you with 4,938 jugs. Then you'll finish that quarter with, say, 5,203. But then the next quarter you plunder your inventory to make room for the new Turbo model. Inventory declines to just 3,027 jugs. Then in the next quarter you finish plundering down to 1,938. And in the last quarter of the year you "restock" and add a bunch to inventory to bring total gallon jugs on your storage shelves to an even 5,000.

So with inventory having moved all over the place, you need a kind of trailing annual average for what you've held and in most cases, you'd just take whatever your quarter-end snap shots were...take an arithmetic average...and that number gives the best indicator of how well or poorly your year was. Things like ROA revolve around inventory so they're an important beast.