One of the most important aspects of running an eCommerce business is the ability to keep tabs on your inventory and its value. You need to be able to determine how much your inventory is worth at any given period so that you can know whether you will reach your revenue goals.
While calculating the weighted average inventory is always a moving target, eCommerce merchants need to choose the right inventory valuation method that will enable them to track their inventory and be able to forecast potential profit.
Luckily, there are several inventory-costing methods that eCommerce merchants can use to determine their weighted average inventory. One such method is the weighted average cost (WAC).
In this article, we will help you decipher what weighted average inventory is and how to calculate it. We will also show you how this method compares with the other inventory costing methods so that you can make an informed decision and choose the right inventory valuation formula for your business. Lastly, we’ll share how merchants can take advantage of Easyship’s global fulfillment network to streamline their logistics and save money on shipping.
What is the Weighted Average Inventory?
Also known as the weighted average cost, the weighted average inventory method is an inventory valuation formula used in eCommerce accounting to determine the average amount of money that goes into the cost of goods sold (COGS) and inventory.
It comes in handy where inventory items are so intermingled, or identical to each other that it is impossible to assign a specific cost to individual units.
Here is why businesses need to know how to calculate the weighted average inventory:
- Makes it easy to track inventory value: It enables a business to keep up with inventory counts, hence making it easy to track and calculate inventory value.
- Less paperwork for businesses: Since the WAC method determines the average value of all items in stock, one doesn't need to keep detailed purchasing records for individual items.
- Less time & resource consuming: The WAC formula is a time-saving alternative of inventory valuation since one doesn't have to count and determine the value of each sellable item separately. It also helps save money and cut overall inventory valuation costs in the long run.
How to Calculate Weighted Average Inventory
The weighted average cost isn't hard to arrive at, even if you are not good at numbers! All you need is to take the total cost of goods purchased, and then divide it by the number of units available for sale. To determine the cost of goods available for sale, add any recent purchases to the total amount of beginning inventory.
Here is the WAC formula:
WAC per unit = Cost of goods available for sale/Total number of units in inventory
Let's look at an example: Let's say your store had a beginning inventory of 300 units for $30 per unit on January 1, 2020. Then you purchased additional units as follows:
Opening inventory: $30 x 300 = $9,000
Jan 20: purchase of 150 units for $40 per unit = $6,000
Feb 15: purchase of 100 units for $35 per unit =$3,500
March 10: purchase of 200 units for $50 per unit = $10,000
Let say your store made the following sales in the same period:
End of February: 120 units
End of March: 60 units
Cost of goods available for sale = $9,000 + $6,000 + $3,500 + $10,000 = $28,500
Total units available for sale = 300 + 150 + 100 + 200 =750 units
WAC per unit = $28,500/750 = $38
In the same period, 180 units were sold. So, we will assign $38 per unit sold, which is 180 x $38 = $6,840. The rest which is $28,500- $6,840 = $21,660 goes to the ending inventory for the Jan-March period.
Comparing the Weighted Average Inventory with Other Inventory Costing Methods
Now that you know how to determine the current value of your inventory using the weighted average inventory method, it is important that you understand how it compares with other inventory valuation methods. That way, you will be able to choose the right method that is right for your business and use it consistently to avoid any discrepancies in your income statements.
Here are the other three methods that you need to be familiar with:
- FIFO ( first-in, first-out)
The FIFO method is excellent for you if you deal with perishables or products that have a shorter shelf life such as groceries, or items that tend to become obsolete, such as electronics.
This inventory costing method is based on the assumption that items produced or purchased first will be the first units to be sold and fulfilled. The downside of the FIFO method is that it doesn't take into consideration the current price of purchases.
So, if you are using value amounts from past months in your accounting, and there is a significant increase in product costs, it will result in misrepresentation of the true cost of goods sold in the income statement. This can negatively impact your profits.
- LIFO ( Last-in, Last-out)
LIFO is an inventory costing method that assumes that items purchased last will be the first items to be sold and fulfilled. Then, the costs of the oldest products are reported as inventory. That means the most recent costs of goods sold will match with sales on the income statement. But this may not always be the case because the flow of costs may not necessarily match the flow of physical units.
LIFO comes in handy in times of inflation when the prices of goods are rising. This helps to keep income higher, and the costs of goods lower. It is also preferable in economic climates characterized by high tax rates because the COGS will be higher and income will be lower.
- Specific Identification Method
This inventory costing method is excellent for start-ups and small businesses that can afford to track every single item in inventory. It is the most accurate method since it individually tracks every single item in stock from the time it is purchased until it is sold out. Though this may work for small businesses, it is not a realistic option for large businesses because it can turn out to be both time & resource consuming.
Choosing The Right Inventory Valuation Method for Your Business
As you can see, calculating the weighted average inventory is very helpful if you want to remain top mind with your inventory levels and value. And there are several methods of doing so depending on your business needs. This will not only make it easier for you to file taxes, but also project sales and compare business revenues in different periods of the year and see how your business is performing.
If your inventory consists of identical or intermingled items, the WAC method can be a game-changer in your business and can make it easier for you to calculate your weighted average inventory, maintain accurate financial statements and save you time and money.
But you don't have to do it all by yourself! As your business grows, inventory management and order fulfillment will become more complicated. At this point, you may need to consider working with a top eCommerce and 3PL company that will offer you different ways to optimize the supply chain and automate most of the inventory valuations process through powerful inventory management software.
With the Easyship global fulfillment network, merchants have access to global warehousing with powerful inventory management software that generates real-time inventory reports, sales forecasting and reorder points. We can offer you access to a network of warehouses, couriers, and all the fulfillment tools you need to reduce inventory carrying costs, reduce human error, and optimize the order fulfillment process.
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