Maximizing Cost Savings: How the Inventory Average Cost Method can Benefit Your Procurement Process

Procurement can be a tricky process, especially when it comes to managing inventory costs. But what if we told you there was a method that could help maximize cost savings? Introducing the Inventory Average Cost Method – a simple yet effective way of calculating your inventory’s worth and keeping your procurement process in check. In this blog post, we’ll delve into how the Inventory Average Cost Method works and explore its benefits for your business. So, let’s get started!

What is the Inventory Average Cost Method?

The Inventory Average Cost Method is a process of calculating the value of inventory that businesses use to keep track of their costs. Essentially, it allows companies to determine an average cost for each unit in their inventory. This method comes in handy when purchases are made at varying prices or when there are fluctuations in the cost of goods.

Under this method, the total cost of all units purchased is divided by the number of units purchased. The resulting figure represents the average cost per unit for that particular period. By using this calculation repeatedly over time, companies can work out a rolling average cost and adjust their pricing accordingly.

It’s important to note that while this method is straightforward, it may not always provide an accurate reflection of your actual inventory costs due to market fluctuations and other external factors. Nonetheless, it remains one of the most commonly used methods globally because it offers simplicity and ease-of-use compared with other more complex calculations.

Ultimately, whether you’re dealing with raw materials or finished products, knowing how much they worth via The Inventory Average Cost Method will give you greater visibility into your company’s financials and help you boost profitability through smarter procurement practices.

How does the Inventory Average Cost Method work?

The Inventory Average Cost Method is a system used by businesses to calculate the cost of goods sold and the value of remaining inventory. This method works by taking an average cost for all units in stock, rather than tracking individual costs for each unit.

To understand how this method works, let’s consider an example. Imagine a business has 100 units of product A in stock. The first 50 units were purchased at $10 each and the second 50 were purchased at $12 each.

Using the Inventory Average Cost Method, we would add up the total cost ($500 + $600 = $1100) and divide it by the total number of units (100). This gives us an average cost per unit of $11.

Now when we sell 20 units of product A, instead of using specific purchase prices for those items, we will use the calculated average cost per unit ($11). If there are still 80 units left in stock after these sales, they will continue to be valued at that same average price until new purchases or sales occur.

This method provides a simpler way to track inventory costs without needing to keep track of individual purchase prices for every item in stock.

How can the Inventory Average Cost Method benefit your procurement process?

The Inventory Average Cost Method can benefit your procurement process in a number of ways. First and foremost, this method allows for greater accuracy when it comes to tracking the cost of goods sold. By averaging the costs of all items in inventory, you can more easily determine the true cost of each item as it is sold.

Another advantage of using this method is that it can help to smooth out fluctuations in prices over time. This means that if there are sudden spikes or drops in price for certain items, those changes won’t have as much impact on your overall costs since they will be averaged out with other purchases.

The Inventory Average Cost Method also helps to simplify record-keeping since you don’t need to track individual costs for each unit. Instead, you only need to keep track of the total value and quantity of inventory on hand at any given time.

Incorporating the Inventory Average Cost Method into your procurement process can lead to greater accuracy, consistency, and simplicity when it comes to managing your inventory and tracking costs.

Are there any drawbacks to using the Inventory Average Cost Method?

While the Inventory Average Cost Method can offer many benefits to your procurement process, there are also some drawbacks to consider. One potential disadvantage is that it may not accurately reflect the true cost of individual items in your inventory.

Another drawback is that this method assumes a uniform cost for all units in stock, regardless of when they were acquired or at what price. This means that sudden changes in market conditions or supplier pricing can impact your average cost and potentially skew your financial reports.

Additionally, using this method requires ongoing monitoring and adjustment to ensure accuracy, which can be time-consuming and resource-intensive. It may also require additional training for employees who need to understand how the system works and what factors influence average costs.

It’s important to note that other methods such as LIFO (Last In First Out) or FIFO (First In First Out) may better suit certain business models or industries. So before adopting any inventory costing method, it’s essential to evaluate its suitability for your specific needs and circumstances.

Conclusion

The Inventory Average Cost Method is a valuable tool that can help organizations save costs in their procurement process. By providing a more accurate cost estimate for inventory items, this method allows businesses to make better decisions when it comes to purchasing goods and managing their stock levels.

However, as with any methodology, there are drawbacks to consider before implementing the Inventory Average Cost Method. It may not be suitable for all types of industries or products and requires careful monitoring to ensure accuracy.

By taking advantage of the benefits provided by the Inventory Average Cost Method while mitigating its potential drawbacks, businesses can optimize their procurement processes and achieve significant cost savings over time.