Understanding Inventory Weighted Average Cost and Inventory Valuation
July 31, 2020
It’s hard to determine if you’re going to reach revenue goals if you don’t know much your inventory is worth. For ecommerce businesses, keeping track of inventory and its value is crucial. By choosing the right inventory tracking method, you can better manage your ecommerce inventory and forecast potential profit.
Since so many variables play into determining the value of inventory (e.g., manufacturing costs, product demand, cost of goods sold (COGS), etc.), knowing the current worth of your inventory can seem like a moving target. Fortunately, there are several inventory valuation methods used in ecommerce that make the process easier. One of the most popular methods for ecommerce businesses is weighted average cost (WAC).
In this post, we’ll go over how to calculate WAC, how this method compares to other inventory valuations methods, and how properly tracking inventory can improve your bottom line.
What is the inventory weighted average?
Inventory weighted average (also known as ‘weighted average cost’) is one of the four most common inventory valuation methods used in ecommerce accounting. This method uses a weighted average to determine the amount of money that goes into COGS and inventory.
How to calculate inventory weighted average cost
To calculate the weighted average cost, divide the total cost of goods purchased by the number of units available for sale. To find the cost of goods available for sale, you’ll need the total amount of beginning inventory and recent purchases. The final calculation will provide a weighted average value for every item available for sale.
Inventory weighted average cost formula (WAC)
To easily calculate WAC, use the simple formula as followed:
Cost of goods available for sale / Total number of units in inventory
Weighted average cost calculation example
Calculating the weighted average cost might seem complicated at first, but it’s simple once you get the hang of it. Here’s an example of how to calculate WAC:
|Transactions for July||Quantity||Cost per unit||Total cost|
|Beginning inventory (July 1)||100||$2.50||$250|
|Ending inventory (July 31)||1,100 units||$2.65 (average)||$2,925|
The total cost of the inventory purchased is $2,925. The total number of units in inventory is 1,100. To calculate the WAC, divide $2,925 with 1,100 to obtain the average weighted cost per unit, which is $2.65.
Comparing WAC to other common inventory valuation methods
Weighted average cost is a great method to determine the value of your current inventory, but it doesn’t necessarily mean it’s the right method for your business. It’s important to choose a method that you will use consistently throughout the year. To make sure you’re using the right method that makes the most sense for your business, it’s recommended that you weigh the pros and cons of each. If you switch methods before the next tax period, it will result in major discrepancies.
Before you choose weighted average cost as your method of choice, be sure to familiarize yourself with the three additional types of inventory valuation methods below and understand how they compare to the WAC formula.
FIFO (first-in, first-out)
The FIFO method assumes that the inventory produced first will be the first unit(s) to be sold and fulfilled. This method is best for perishables, or products that have a shorter shelf life or become obsolete. The downfall of this method is that if product costs significantly increase and your accountant is using value amounts from months ago, it can negatively impact profits or be misrepresented on an income statement.
LIFO (last-in, last-out)
The LIFO method records the most recently purchased products in the inventory as sold first, and the lower cost of older products will be reported as inventory. During times of inflation, LIFO results in higher COGS and a lower balance of remaining inventory.
Specific identification method
The specific identification method provides the most accurate unit cost since it tracks every single item in stock individually from the time it arrives to when it is sold. This is a common method for small businesses and startups that can keep up with tracking every item in inventory, but it’s not a realistic approach for large businesses.
Compared to the other common inventory valuation methods, WAC is the ideal method for direct-to-consumer brands that have a high volume of inventory with items that are similar in cost. For example, if you sell different scents of perfumes in the same size bottle, you might have several unique SKUs, but the value of each item is the same.
What are the advantages of the inventory weighted average method?
The inventory weighted average method is one of the most common inventory valuation methods because of the many benefits that it offers, such as time savings and consistency. Here are some of the advantages of using WAC in your overall inventory management process.
1. Easily track inventory value
Keeping up with inventory counts is one thing, let alone tracking the costs it takes to purchase and store inventory. Unlike FIFO and LIFO that use a range of costs, the WAC method uses a blended average, making it easier to calculate and track inventory value.
“We have access to live inventory management, knowing exactly how many units we have in each ShipBob fulfillment center. It not only helps with our overall process in managing and making sure our inventory levels are balanced but also for tax purposes at the end of the year. ShipBob made that entire process very simplified for our accountants and us.”
Matt Dryfhout, Founder & CEO of BAKblade
2. Less paperwork for you
The WAC method requires a single cost calculation to determine the average value of all items in stock. Since every item is valued at the same amount, there is no need to maintain detailed inventory purchasing records, which means less paperwork to keep track of.
3. Cut overall costs
The cost of managing your inventory can cut into profits if you don’t take the time to optimize the process. Instead of counting up each sellable unit and then adding up the value of each product, the WAC formula provides a time-saving alternative to calculate current inventory value, which helps you save money in the long run.
Other ways to simplify your process and reduce the costs associated with managing inventory are to use inventory management software and/or partner with a third-party logistics (3PL) company that provides inventory management tools, ecommerce warehousing, and real-time inventory reports. By optimizing your inventory management process and reorder quantity, you can reduce human error, spend less on labor, and save on inventory carrying costs.
“I felt like I couldn’t grow until I moved to ShipBob. Our old 3PL was slowing us down. Now I am encouraged to sell more with them. My CPA even said to me, ‘thank god you switched to ShipBob. ShipBob provides me clarity and insight to help me make business decisions when I need it, along with responsive customer support.”
Courtney Lee, founder of Prymal
How outsourcing inventory management allows you to scale
Inventory management and order fulfillment become more complicated as ecommerce businesses grow. Without finding ways to optimize the supply chain and consistently track inventory and its value, it can be a challenge to scale.
Outsourcing fulfillment to a 3PL like ShipBob that offers inventory management services, analytics, and technology can help you scale faster. By partnering with ShipBob, you can focus your time on expanding your business and improving the customer experience, while we take care of fulfillment and inventory management tasks for you.
“Having confidence in scaling fulfillment is hypercritical for us. With ShipBob, we find comfort in knowing we can scale and have orders fulfilled in a quick manner.”
Tim Fink, co-founder of EnduroSport
Consistency is key when it comes to managing inventory levels and can help make the process of filing taxes and comparing financials year over year much easier.
If you’re selling multiple SKUs of similar products, the WAC method is a great way to easily determine inventory value and maintain accurate financial statements. By using the inventory weighted average cost method, you can track the value of inventory year over year for proper inventory accounting while saving time doing so. But there’s a lot more that goes into inventory management than keeping tracking of value.
ShipBob offers a full suite of fulfillment services with built-in inventory management tools, including demand forecasting, order management, and data and analytics. You can avoid the headaches associated with tedious inventory management tasks by partnering up with ShipBob. To learn more about how ShipBob can help your business scale, click the button below for pricing and more information.