Top 10 Inventory Metrics For Small Businesses & How to Calculate Them
Product-based businesses must focus on inventory metrics to identify how accurately their stock is being managed. This can provide clarity on the effectiveness of their operations.
On average, inventory metrics are only accurate 63% of the time for retail businesses. Furthermore, 88% of managers working within a supply chain estimate that inventory levels could be reduced by over 5% through the use of enhanced technology and procedures to increase accuracy.
This is why inventory metrics are so important in stock management and cycle counts. The metrics can provide a quantifiable way of tracking accuracy, which equips businesses with the information they need to develop more efficient inventory strategies.
Inventory Metrics Defined
When referring to inventory metrics, the term inventory KPI' is often used (Key Performance Indicators). These KPI's are present to hold businesses accountable and notify management when performance is falling short of expectations.
The key to choosing the right KPIs is based on your unique business goals. Businesses should get clear on milestones for specific periods - like monthly or quarterly goals - and assess the necessary KPI data for these periods.
Key Inventory Metrics and Their Calculations
The metrics a company chooses to use will be based on the goals they set for their operations.
Below are the top 10 inventory metrics for product-based businesses and how to calculate them.
1. Inventory Turnover Ratio/Percentage
Also known as the days on hand, metric refers to the number of times inventory is sold within a certain period of time (quarterly, or yearly, for example).
If the turnover number is low, this could indicate the company is experiencing too little sales or too much stock. In essence, the goods aren't selling as expected. The ideal situation would be to raise the inventory turnover rate to spend less on storing stock while maintaining a consistent inventory level.
Inventory Turnover = Cost of Goods Sold / Average Inventory
2. Gross Margin Percentage
This metric depicts the percentage of sales revenue that is gross profit. If the gross margin percentage is small, a business could focus on increasing inventory turnover, as more sales would lead to higher profit margins (in the case where the gross margin for each sale is the same).
A weak gross margin could also point to the supplier price needing further negotiations. If companies are able to lower the costs of inventory purchased from suppliers (possibly by bulk ordering), this could lead to a higher gross margin.
Gross Margin Percent = (Total Sales Revenue - the Cost of Sales) / Total Sales Revenue X 100
3. Order Fill Rate
This metric is based on order fulfillment and reveals how consumer needs are met by the company. As a percentage, it shows the orders that have been satisfied with the stock that the company has available. Essentially, a company aims to be at a 100% order fill rate. If the percentage is below 100, this could lead to decreased customer retention and lost sales due to missed opportunities.
Order Fill Rate = Orders Shipped / Total Number of Orders
4. Lead Time
This refers to the time it takes for suppliers to replenish the inventory. It's important to know the average lead times for certain products as it will dictate the amount of stock needed to be kept on hand to fulfill orders without delays.
If the lead time is long, more stock needs to be stored as it will take some time between ordering from suppliers to actually receiving the products.
Lead Time = the Supply Delay + the Reordering Delay
5. Cycle Time
This is the average time it takes for the product to be delivered to the customer after their order has been placed. The whole fulfillment process is taken into account here, so it includes the warehouse packing as well as the shipping time.
Shorter cycle times are desirable as they would indicate efficient processes. Businesses can reduce their cycle times by organizing the storage more effectively so the goods are easy to locate and access.
Cycle Time = Ship Date - Customer Order Date
6. Cost of Carrying
Also known as the holding cost, this inventory metric is based on fixed and variable costs that are associated with storing and handling goods, as well as expenses due to damage and theft.
Not knowing the holding cost could mean that businesses are buying more inventory than they can afford to carry, or investing in space or labor that is not necessary to handle their volume of stock. Businesses can lower their carrying costs by simply reducing their inventory.
Cost of Carrying Inventory = Sum of All Carrying Costs (handling, rent, etc.) / Overall Cost of Inventory
7. Average Days To Sell Inventory (DSI)
This measures how long a company takes to turn its inventory into sales. It will depend also on the industry and the types of products the company offers, as items that are more expensive will generally take longer to sell than smaller ticket items or those that are perishable.
It's important to use this metric to determine how long capital is tied up in inventory, which points to how efficiently a company is able to experience a cash conversion cycle (turning inventory to cash).
Average Days To Sell Inventory (DSI) = (Average Inventory / the Cost of Goods Sold) X 365
8. Average Inventory Level
This metric is used to determine the estimated amount of inventory on hand during a certain period. Companies using this metric are seeking limited spikes or drops in inventory levels, which means there's a healthy flow of stock coming in and going out.
Stock levels will inevitably fluctuate based on supply and demand, though when calculated as an average over a year, it can give a more broad overview without seasonal changes skewing the numbers dramatically. When using this metric compared to the overall volume of sales, businesses can track inventory losses due to damage, product expiry, and theft.
Average Inventory Level = (Current Inventory Level + the Previous Inventory Level) / 2
9. Return On Investment
Also referred to as the GMROI (Gross Margin Return on Investment), this metric displays how much a company earns for every dollar that has been invested in inventory.
Any number that is more than 1 means that the goods are being sold for more than what was paid, which indicates a profit. A company would be losing money if their GMROI is less than 1. This is an effective metric when determining whether a business should continue investing in a particular product.
Return On Investment = (Sales / Average Cost of Inventory) X Gross Margin
10. Inventory Accuracy Percentage
This is one of the most commonly used inventory metrics, as it reveals how accurate inventory records match the volume of physical stock. At least a 95% accuracy rate is considered to be good inventory management and indicates strong warehouse productivity.
1 - (sum of the variance ) / (sum of the total inventory) X 100
It's apparent that many of these inventory management metrics will interact with one another, so knowing how to calculate these key metrics is necessary in order to calculate the others that are most relevant to a company.
Expert inventory management systems leverage the use of automated software to reach this level of accuracy. By integrating with the point of sale systems, inventory management software can perpetually track stock levels and produce variance reports to reveal any discrepancies in data.
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