Inventory management is a key factor in the success of every business: from ordering inventory to counting stock accurately, understanding your business' inventory is essential.
In this article, we look at one way you can do this, namely, the weighted average cost method. This method is commonly adopted by manufacturers and other companies which stock large quantities of product at any given time.
The basics
The weighted average cost method is an accounting method used to value a company’s inventory stock. The method requires identifying the average cost of inventory on-hand for a Stock Keeping Unit (SKU), against each item in the group.So, when should you use the weighted average cost method?
The weighted average cost method, like all costing systems, will have disadvantages and advantages for different businesses. However, the weighted average cost method may be particularly useful for businesses where tracking the cost of individual units is difficult, or where individual units of an SKU are indistinguishable. You may also consider using the weighted average cost system if the costs associated with your business' raw materials fluctuates often but stay within a reasonably stable price bracket. In addition, the weighted average cost method may work well for your business if you tend to purchase inventory stock on a regular basis. The simplicity of the average costing system means that minimal maintenance is required: in effect, the transactions do the maintenance and therefore this method tends to provide more accurate cost calculations, which may otherwise require staff time to track on an individual basis.Which types of businesses benefit from the weighted average cost method?
Certain businesses are particularly suited to adopting the weighted average cost method. Manufacturers, for example, can benefit from the method since their inventories are often stockpiled or intertwined, making it difficult to differentiate between older and newer items. Agricultural businesses also often benefit from the weighted average cost method because any product that is grown in a field and mass harvested cannot be accounted for individually. In the same way, many animal products are also stored in larger quantities and similarly cannot be differentiated individually. Fuel companies will also benefit from adopting the weighted average cost method, since the product is stored in large quantities and batches cannot be differentiated from one another. Likewise, pharmaceutical companies will also benefit from using this method.