If you have a business that sells products, you’re already aware of the value of inventory management.
Inventory management not only helps you keep the right amount of products on hand to keep customers happy, but will also assist with price control as well.
Where inventory management starts to become more complex is in the wide range of methodologies you can use to track your stock. Unfortunately, there’s no one size fits all solution when it comes to managing your inventory. Therefore, you’ll need to understand the different options available to you in order to select an approach that’s right for your business.
Today, we’ll talk about one method used for better pricing control: the moving average price.
What is the Moving Average Price?
Before getting into the details, we should first discuss the moving average price definition.
Moving average price is an inventory costing method wherein “the average price of the product is calculated after every goods acquisition.”
This, along with standard price, are two of the most popular methods for inventory costing. To calculate this, we use the moving average price formula. Simply add the price of new product to the price of existing product you already have in your inventory. Then divide this by the total number of products.
Moving Average Price = Products On Hand Value + New Products Value / Total Number of Products
You purchase 100 new items at a total cost of $500. You already have 100 items in inventory at a total cost of $1,000. We’d set up the formula like this:
$1,000 + $500 = $1,500 inventory cost.
$1,500/200 total items in inventory equals $750. That is our moving average price or moving average cost per unit in this scenario.
As the name implies, the average moving price is a constantly recurring calculation. It will potentially change with each invoice, receipt, or goods settlement.
Why is Moving Average Price important?
Most companies are in the business of selling products. This means they hope to continually sell old stock and replace it with new stock. In some instances, where prices for materials are stable and rarely deviate, tracking the cost of producing products is simple.
However, if you run a business where the value of materials or products can fluctuate on a daily basis, moving average inventory provides a much easier way to keep track of what producing your product is costing you.
A commonly cited example of how moving average price works involves companies in the gas and oil industries.
Assume you run one of these businesses. Each day, you receive a new shipment of gas, but as we all know, gas prices can fluctuate wildly from one day to the next. If you have 200 gallons of yesterday’s gas on hand, but get another 200 gallon delivery today, there’s no practical way to track which of those 400 gallons came in the first shipment and which came in the second.
In this instance, the moving average price method allows you to continually have one price for your entire inventory that takes into consideration the different amounts you paid for each shipment.
Armed with this knowledge, you’re then able to adjust your own sales prices accordingly based on the value of the stock you have in inventory.
Beyond that, it allows you to better track your company’s financial situation by making it easier to calculate your cost of goods sold, net sales, and assets.
Standard Price Method vs. Moving Average Price
Moving average price is one of two popular methods of pricing control. The other is standard pricing. You may be wondering what the difference is between the two.
We know that moving average pricing is constantly updating with our inventory as new items are added and removed, giving us a constantly changing figure to work with. In standard pricing, items are valued with an amount that remains constant for a certain amount of time. This could be a quarter, a month, a week, or whatever time frame you select.
Because the moving average is constantly updating, it can be both more accurate and more volatile (depending on circumstances). However, if you have a business where material and product prices are more consistent, the standard price method may actually provide you with better data.
Ultimately, it’s a matter of choosing the solution that’s best for your business. Knowing the difference between the two philosophies can help make the decision process easier.
What are the advantages of using the Moving Average Price Method?
Like all inventory tracking and management approaches, there are pros and cons to using the moving average price calculation to manage your inventory.
Here are the pros:
1.Using moving average price helps companies better track their inventory
Since moving average inventory is constantly updated with each addition or subtraction of your stock, it gives you an always up-to-date overview of where things stand. Armed with this knowledge, inventory management and pricing become much simpler and involve less guesswork.
As demonstrated above, the formula used to calculate moving average price is not complex. This simplicity means it’s easy for almost anyone to understand, which makes implementation less of a challenge.
3. Great for forecasting costs
One area where the moving average price really shines is when it comes to forecasting costs for raw materials and other goods you’ll acquire to make your products. Understanding the moving average price of these materials will allow you to approach pricing with a better grasp of actual production costs.
What are the disadvantages of the Moving Average Price Method?
It’s hard to argue that there aren’t legitimate positives to using the moving average price approach to help manage your inventory. However, there are some issues you should be aware of before making a decision to commit to using this methodology.
1. The numbers are variable
One of the key challenges in using this approach to inventory management is that while it’s constantly updating with new data as stock is added or removed from inventory, those figures are not always completely accurate.
What that means is the prices used to calculate the moving average price are based solely on the time the items are added to inventory. If there’s an issue in your supply chain (like a hurricane making items harder to get or seasonal variances as just two examples), then you may pay more or less than normal.
2.It can cause inaccurate pricing
Point one brings us directly to point two. If the price of the goods you’ve added to inventory are skewed unnaturally, that number can mess up the math down the line as well.
One of the key uses for moving average pricing is to make sure you’re always charging the right amount for your products. However, if there’s a weird fluctuation in what you pay for inventory, that fluctuation will also affect your product’s selling price if you don’t manually take that into consideration.
3. It can impact material valuation
Taking that one step further, it can also skew your material valuation numbers too.
The thing to remember here is that running a moving average price approach is great, but there will be times when you might have to deviate from the numbers based on market fluctuations.
If you understand that and prepare for these periods and manually adjust accordingly, these disadvantages become less of an issue.
Methods for calculating Moving Average Price
Earlier in this article, we discussed the formula to calculate the moving average price for your business.
However, that’s not the only way to figure out this number. Here are several other options you can utilize.
- Use Standard Reports
- From Multiple Table Mapping
- From the Info Structures Table
Diving into how each of these works is a bit beyond the scope of this article, but the key thing to remember here is that there are a lot of options available when it comes to determining the moving average price.
These figures can be obtained through using formulas on Excel spreadsheets, but it’s possible to simplify the process even further with an inventory management software solution that features point of sale integration.
Moving average pricing can allow you to get a better handle on your business’s inventory and pricing plans because it provides you with a constantly updated snapshot of your costs.
Knowing how much of your finances are tied up in products and materials allows you to forecast for the future, and makes it easier to adjust prices on the fly to either seize opportunities or avoid financial pitfalls.
While there are both pros and cons to using this method, moving average pricing is easy to calculate, simple to understand, and requires little effort to implement. This means you won’t waste a lot of time with complex math formulas or training your team on how to use it for maximum effectiveness.
The potential disadvantages of the moving average price approach are easily overcome, too.
Best of all, if you utilize inventory management software you can essentially set things up to run with almost no effort on your end.
These are just some of the reasons why we feel any company with lots of inventory with fluctuating prices should consider the moving average price method. Give it a shot and see if it works for you.
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