10 Inventory Metrics You Need to Know Right Now
How’s Your Business Doing?
As a busy wholesaler and distributor, in between receiving purchases and fulfilling orders, I’m sure you must wonder how you’re business is doing.
You can with inventory metrics.
Why should you care about inventory metrics? Because as an indicator of stock control, they give you an insight into how your stock touches every part of your business operations.
With these indicators, you can benchmark your operations performance over time and against the industry average.
We’ve done all the hard work for you. We think these are the top 10 inventory metrics that you need to know right now.
Top Ten Inventory Metrics
Let’s start with the most critical one that everyone talks about first when this topic comes up.
1. Inventory Turnover
Inventory Turnover = Cost of Goods Sold / Average Inventory
This is the number of times inventory is sold within a period of time, typically a year.
Why do you need to know this?
A low turnover may suggest that you’re overstocking, dealing with obsolete goods, or that you have issues with the product or your marketing efforts. Basically, your goods are not selling as expected.
On the other hand, a high turnover rate may mean inadequate stock and a potential loss in sales as the inventory level is too low. You may be experiencing stock shortages because you underestimated demand, or the product has gone viral and sales have gone off the charts.
Ideally, you want to increase your inventory turnover and reduce your holding of inventory for a couple of reasons.
Firstly, increasing your turnover means reducing your holding cost. It costs money to keep stock! Warehouse rent, insurance, theft and Acts of God are all costs and risk associated with inventory. It’s in your interest to minimize your inventory levels.
Secondly, reducing your holding cost means increasing net income and profitability, assuming that your sales stay consistent. This looks far better for your financial reports and keeps your accountant happy.
Finally, stocking items that turnover quickly means being responsive to the market and customer demand, while at the same time reducing and replacing obsolete items or deadstock. This is a common scenario for seasonal, fast fashion and technology products.
2. Gross Margin Percent
Gross Margin Percent = (Sales – The Cost of Sales) / Sales
This is the percentage of selling price or sales revenue that is gross profit.
Let’s say that you have an 18 percent gross margin. You can assume that out of $1 million in sales, your profit margin will be $180,000.
Why is gross margin percent so important?
Gross margin percent works hand in hand with inventory turnover. If you have weak gross margins, you might want to focus on increasing your inventory turnover. Assuming the same gross margin for each sale, more sales means a higher level of profits.
Also, your gross margins may reflect your relationship with your suppliers and their pricing. The more power and control your suppliers have, the higher the prices! If you can negotiate the prices and costs for your purchases, a lower cost of inventory means a higher gross margin.
3. Customer Order Fill Rate
Customer Order Fill Rate = Orders that are Shipped in Full / Total Number of Orders
This shows how you are servicing your customers. It shows what orders your customers are getting on time.
It is important because it affects your customer satisfaction and retention rate. Ideally, you should be aiming for 100%.
If you’re below 100%, your customers might start to doubt your ability to deliver what they want on time, and they may order from your competitors.
How can you improve the customer experience?
You may need to invest in a software solution that shows you real-time inventory levels. Or find a way to keep your sales reps well informed of inventory data to help them ship accurate and complete orders.
4. Cost Of Carrying
Cost of Carrying = Carrying Costs / Overall Cost
The cost of carrying is the percentage that represents the cents per dollar that is spent on inventory overhead per year.
Carrying costs include fixed and variable costs such as storage, handling, obsolescence, damage, theft and general administration.
Don’t forget to include the opportunity cost of capital because your money is currently tied up in stock. This is the return you could reasonably expect if you had used the money elsewhere.
All in, this adds up to a lot of costs!
Why is the cost of carrying important?
A low cost of carrying suggests that inventory is cheap. Not having an accurate value for carrying costs means that you may decide to purchase more stock than you really need, or increase your investment in more warehouse space and forklifts that you don’t need right now.
How can you reduce your cost of carrying? Start by reducing your inventory. Analyse your sales reports for slow-moving, obsolete or dead stock inventory.
Also, take note of fixed versus variable costs and reduce them. Warehouse rent and forklifts are fixed costs as they don’t change with your inventory level. Insurance and taxes are variable costs as they are typically a percentage of your inventory’s value.
5. Average Days To Sell Inventory
Average Days To Sell Inventory = (Your Average Inventory/The Cost of Goods Sold) x 365
This is how long it takes a company to turn its inventory into sales, that is, the average length of time that your cash is tied up in inventory.
It is a measure of your inventory management efficiency, hence a lower number is preferred. However, the average days to sell inventory varies between industries because of differences in the products and business models. Hence, it is important to compare the number to other similar companies.
For example, businesses that sell perishable or fast-moving products such as food will have a lower number than those who sell non-perishable or slow-moving products such as cars or furniture.
Why is this indicator important? Because it represents the start of your cash conversion cycle: the process of turning your raw materials into cash.
This indicator is typically read together with the inventory turnover ratio. As you have seen, a low inventory turnover suggests overstocking, marketing/product issues, or poorly managed inventory.
6. Return On Investment
Return On Investment = (Sales / Average Cost of Inventory) x Gross Margin
This is also known as Gross Margin Return on Investment (GMROI). It shows how much you are earning for every dollar invested in your inventory.
A number more than 1 means that you are selling the goods for more than what you paid for them. Likewise, a number less than 1 means you are selling them for less than their cost price.
GMROI can be used to measure the performance of the entire business, but it is more effective if used for a particular category of goods.
7. Item Fill Rate
Item Fill Rate = Received Quantity / Ordered Quantity
This can be used to measure the order fulfillment performance of a single delivery or for all deliveries during a time period.
The term “line” refers to a line on the order since a typical delivery order or shipment will display the name of each ordered product and quantity in its own line.
For example, a customer placed a 10-line order with 10 items on each line. If the customer receives the shipment with 100 items, with all of them matching the products on each line, the line fill rate is 100%
However, if one line is missing one item, the line fill rate for that order falls to 90%. If that same line is delivered with only two of the 10 items on the line, the line fill rate will still be 90%, as only one line on the shipment failed to match the order.
On the other hand, if three lines on the shipment are each missing just one item, the line fill rate will drop to 70%.
There is no magic number for the item fill rate but it is suggested that 95% and above is a figure that you should be aiming for.
8. Cycle Time
Cycle Time = Actual Ship Date – Customer Order Date
The customer order cycle time is the average time it takes from order placement by the customer to final delivery to the customer.
It is the time taken to complete all stages in the fulfillment process, for example, picking and packing in the warehouse and shipping time.
So it goes to say that if your processes are efficient, your cycle time will be shorter. If they are inefficient, it will be longer.
Benchmarking your customer order cycle time is important. A longer order cycle time means that you may have trouble attracting and retaining customers who are kept waiting for their orders.
So, how can you reduce your customer order cycle time?
For a start, you can reduce the physical travel time for the stock. You can organize the warehouse space for optimum travel and activity.
Also, you can try to understand your customer profiles better so that you can quickly serve and fulfill them.
Finally, consider using inventory management software to prevent stock-outs and prioritize reorder quantities.
9. Average Inventory Level
Average Inventory Level = (Current Inventory + Previous Inventory) / 2
This is the mean value of inventory throughout a certain time period.
Inventory levels often fluctuate throughout the year, depending on supply and demand. The average inventory level shows the amount of inventory a business typically holds over the year. This removes the influence of seasonal changes and factors.
The average inventory level is used to compare against overall sales volume. This allows you to track inventory losses that may have occurred due to theft, shrinkage, damage or product expiry.
10. Inventory Accuracy
Inventory Accuracy = Regular Stock Takes
This refers to how closely your inventory records match your physical inventory.
You can’t manage inventory if you don’t know what you have in stock. Good inventory management requires at least 95 percent accuracy.
This means you should have regular inventory counts. Do this by taking a random sampling of stock and check if anything is missing. Ideally, you should count the items that generate most of your sales several times a year. Slow-moving products need only an annual count.
A stocktake can be measured by value or count. Both methods give different results for different purposes.
Accountants prefer dollar-based measurement. They want to make sure that the inventory value in the books is accurate on the whole. Little discrepancies for individual items do not concern them so long that the in-going and out-going discrepancies are roughly equal and the total value is the same.
On the other hand, operations staff prefer something count-based. They are preoccupied with the accuracy of individual SKUs. If there is a discrepancy in one SKU, it is sometimes not possible to simply substitute it with another product. They are not interchangeable.
Why is inventory accuracy important?
Stock-outs increases cost and time for everyone involved. Warehouse staff waste time looking for misplaced or missing items, and there are delivery delays.
Most importantly, sophisticated inventory management systems require high accuracies of at least 95% to function well and generate the ROI on your software investment. Inaccurate inventory can only hold back your inventory management solution.
Start Benchmarking Your Business Now
So, there you go, the top ten inventory metrics that you should know right now.
Now it’s your turn to apply them to your business operations and gauge your performance and efficiency with stock control.