Weighted average cost

Weighted average cost is a way of valuing stock when you buy the same item at different prices. Instead of tracking which lot each unit came from, you add up what you paid for all units and divide by the number of units. Every unit then carries that average cost until the next purchase changes it.

The formula

Average cost per unit = total cost of units in stock ÷ number of units in stock.

Example

A wholesaler buys 20 tins of ghee at Rs 2,600 (Rs 52,000) and then 20 more at Rs 2,800 (Rs 56,000). He now has 40 tins that cost Rs 108,000 in total. The average is 108,000 ÷ 40 = Rs 2,700 per tin.

He sells 25 tins. The cost of goods sold is 25 × 2,700 = Rs 67,500. The 15 tins left are valued at 15 × 2,700 = Rs 40,500. Together, 67,500 + 40,500 = Rs 108,000, which matches what he paid.

Under FIFO, the same sale would cost Rs 66,000 and leave stock worth Rs 42,000. The total is the same; only the split between sold and unsold changes.

Why it matters

Average cost smooths out price swings, which suits goods like ghee, sugar, rice and cement, where every unit is identical and lots are mixed in the godown. It also makes profit per sale easier to read, because every unit of an item has the same cost at any one time.

How software handles it

Recalculating the average after every purchase by hand is tedious. Inventory software updates it as purchases are entered. Whichever method you choose, use it consistently from month to month so your profit figures can be compared. See stock valuation.