8 min read
29 Nov 2021
8 min read
29 Nov 2021
Make the most of your inventory management process with these X inventory management KPIs which will help you to accurately monitor and improve performance, resulting in more efficient operation.
Inventory management is a core procedure in most businesses’ daily operations, ensuring that goods and materials are where they ought to be when they’re needed. But to get the most out of your inventory management process, you need to intelligently monitor performance. Setting KPIs is the best way to monitor how well you currently manage your inventory and should give you all the insights you need to gradually work on improving performance.
We’ve put together a list of some of the most valuable inventory management KPIs, so you can choose the ones that make sense for your business and start to get valuable information about just how well you’re managing your inventory.
First, you should constantly have a handle on how much inventory your business has on hand at any one time. Under most circumstances (excluding businesses that rely on seasonal demand), the objective is to have average inventory remain mostly level. Too much inventory and your holding costs will increase unnecessarily, too little and you might have issues with stock-outs.
By regularly monitoring the average amount of inventory you hold, perhaps monthly, you can determine whether you’re over- or under-buying and iron out the spikes and drops to make your approach to inventory management more efficient.
To calculate the average inventory in a given month, use this formula:
(Inventory at the beginning of the month + inventory at the end of the month) / 2
Next, it’s useful to know how much inventory shrinkage you’re experiencing by monitoring and analyzing the difference between the amount of inventory you’re actually holding and the amount you should be holding according to your inventory management database.
The dangers of mismatches between the two are particularly threatening if your actual amount of inventory is lower than what your books show, as you might find yourself in the situation of selling something that you don’t have to hand, creating a dissatisfied customer.
Having more inventory than your data indicates is less of a bother, but still shows that a process somewhere is being mismanaged. The goal is to reach a perfect level of inventory accuracy – where the actual amount of inventory you have matches what your database says.
Calculating your inventory accuracy is relatively simple, using the following formula:
Actual inventory – inventory recorded in your database
It might not feel like it, but inventory can be seen as a liability rather than an asset when you consider that it costs money to keep hold of it. This is often referred to as the real cost of inventory, and is the sum of a number of individual costs including warehouse rent, staff wages, and loss through inventory deterioration.
Managing your cost of holding inventory, or at least staying aware of it, is a critical part of inventory management, as the costs incurred by having inventory will implicitly affect the profitability of selling it. Having a breakdown of your holding costs on a line-level can also help you to identify where you might be overspending, meaning you can take steps to reduce your costs and increase profitability.
Holding costs can be calculated by adding together all the individual costs involved with owning inventory
How quickly your inventory turns over or, in other words, how many times it’s sold and replenished in a given time-period, is generally referred to as inventory turnover or days on hand. It’s a performance indicator that represents how long it takes to sell a batch of goods and comes in useful when understanding how much it costs on average to hold inventory.
There is no right inventory turnover rate to aim for – the ideal rate depends on your specific business. Ideally, though, it will ensure that none of your inventory is held long enough that it deteriorates. It’s often calculated on an annual basis, providing ongoing insights about whether your inventory management approach is suitable given your velocity of sales.
You can calculate inventory turnover using the following formula:
Cost of goods sold / average inventory
A similar KPI to inventory turnover, average days to sell inventory is intended to measure how long, on average, it takes your company to turn inventory into sales. In other words, it’s a measure of how long your businesses’ current inventory levels will last. It’s used in much the same way as inventory turnover – providing insights into how much it costs to hold on to a batch of inventory.
The ideal average days to sell inventory figure depends entirely on what sector you operate in. Expensive items will typically sell at a much slower rate than cheaper ones, so make sure to bear in mind that your figure will not necessarily be comparable with any other businesses’.
Average days to sell inventory can be calculated using the following formula:
(Average inventory / cost of sales) x365
The phrase stock-out is essentially another way of saying sold out, which is obviously never a situation a business wants to find itself in. To be out of stock is to be without inventory to sell, meaning revenue inevitably grinds to a halt and the only productive thing to be done is ordering more inventory. Therefore, it’s easy to see why you’d want to avoid stock-outs at all costs.
And the first step to avoiding them in future is to understand when (and how) they occur, which is the intention of this inventory management KPI. It simply measures the number of times in a given time-period demand has been left unfilled because of a lack of inventory. In essence, it provides a macro-overview of how effectively a business is purchasing or producing the goods that they sell.
Measured by counting the number of times an order goes unfulfilled because of a lack of inventory
This can also be represented as a percentage by using the following formula:
(Number of orders unfulfilled due to lack of stock / Number of orders placed) *100
Moving away from customer-centric KPIs and towards supplier-centric ones, lead time is an important KPI not just for inventory management but also for supply chain management as a whole. It is a measure of how long it takes your suppliers to deliver an order from the moment it’s placed and has a large impact on your approach to inventory management.
Ideally, you want lead time to be as low as possible, indicating that you can receive deliveries of goods or products from suppliers with a quick turn-around, which mitigates the potential impact of stock-outs. Calculating lead time for each of your suppliers helps you to understand which parts of your inventory can be replenished quickly, and which need better planning.
To calculate lead time for a specific supplier, use the following formula:
Order process time + production lead time + delivery lead time
Continuing with another KPI that measures how your suppliers can impact your inventory management approach, supplier quality index is a holistic measure that aggregates a range of individual qualities of a supplier. Establishing supplier quality index as one of your inventory management KPIs is one of the best ways of creating a proprietary supplier ranking system, which can also help you to avoid potential supplier risks.
There are plenty of areas of a supplier’s performance that can be factored into supplier quality index, such as the quality of goods delivered, the standard of their corrective actions, and how communicative the supplier is. Each individual element can be weighted according to its importance to your business, and the resulting score represents how good a supplier is.
The supplier quality index calculation is variable depending on the metrics you choose to measure, but an example formula is below:
(Quality of goods x 50%) + (standard of corrective actions x 25%) + (communication x 25%)
The perfect order rate KPI measures the percentage of orders you ship that fulfil all the following criteria: the right products, delivered in the right quantity, to the right place, in the right packaging, with the right documentation, at the right time. It’s essentially an indicator of how effectively your inventory team are delivering the goods you’ve sold.
A high perfect order rate is indicative of excellent operation and will typically result in high levels of customer satisfaction. A low perfect order rate signifies that your operation is lacking in certain elements but understanding where you’re falling short most is essential to be able to rectify your mistakes.
Perfect order rate is another variable KPI, depending on the parameters you believe make up a perfect order, but generally the formula is as below:
((Number of orders delivered on time / number of orders) + (number of orders completed / number of orders) + (number of orders delivered damage free / number of orders) + (number of orders delivered with accurate documentation / number of orders)) x 100
And finally, there’s rate of return. This is a very simple metric that assesses what percentage of orders shipped end up being returned – essentially acting as a proxy for the perfect order rate KPI, provided you assume non-perfect orders would be returned. As well as tracking the number of orders that are returned, it’s also highly useful to keep track of what each reason for return is so you can avoid making the same mistakes again.
Focusing on minimizing the rate of return is one of the most effective ways of tackling low customer satisfaction. It will help you to uncover problems in your supply chain, manufacturing process, or approach to inventory management, and deliver insights into how to resolve them.
Rate of return is calculated simply using the following formula:
(Number of items returned / number of items shipped) x100
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