Inventory Management KPIs for Effective Inventory Analysis
Managing inventory is a complex business. Lots of activities, processes and people are involved in ordering, receiving, storing, picking and shipping items with the ultimate aim of keeping customers happy with the correct orders that are on time.
Inventory management KPIs are important as they help analyze and track the performance of inventory management activities such as how stock is ordered, managed and turned. Inventory management KPIs are important to measure the progress of supply chain objectives and identify areas for improvement.
But with a wealth of inventory KPIs available to choose from to include in your inventory analysis methods, which ones are the most important to ensure you’re on the right track to optimum efficiency? Here’s some of the most common inventory management measures you can track for success.
How to Choose Inventory Management KPIs
- KPIs need to be SMART — avoid any that are too broad and are difficult to quantify and measure. SMART goals are specific, measurable, achievable, relevant, and timely. So instead of saying “we’d like to increase our stock turnover” it becomes “we’d like to increase our stock turnover by 2% by the end of this year”.
- Ensure KPIs all contribute towards your organization’s strategic goals whether these are customer service targets, growth strategies or profitability objectives.
- KPIs will influence how employees carry out their jobs, so ensure the metrics you choose promote the right collaborative behavior and avoid any that encourage competition between departments.
Don’t forget once your KPIs are in place, they need to be tracked and communicated on a regular basis across your business. Employees need to understand their importance and how they’ve individually impacted performance. Offer praise when you’re performing well and feedback when performance needs to improve to keep everyone motivated towards the same goal.
Inventory Management KPIs — Examples for Effective Inventory Analysis
1. Inventory turnover ratio
Inventory turnover ratio measures how quickly stock is sold and replaced, or turned over, in a predefined time period (usually a year).
A common way to calculate an inventory turnover ratio is:
Inventory turnover is a good indicator of the efficiency of your inventory management processes. A higher turnover generally means greater efficiency. However, be careful not to simply lower inventory levels across the whole warehouse to improve your turnover rate, as this could be at the expense of order fulfillment.
2. Demand forecast accuracy
Aiming to get your demand forecasting as accurate as possible is critical to ensure stock availability so you can maximize sales and keep customers happy while preventing excess stock.
This KPI analyzes how accurate your forecast was against actual sales. The less of a gap between what was forecasted and what was sold indicates that your demand forecasting is strong. The more accurate your demand forecasts are, the better your inventory turnover rates and the lower your carrying costs.
Demand forecasts can be set by sales teams based on qualitative data or historical sales figures. However, often statistical demand forecasting calculations that take into account demand types, trends and seasonality will be much more accurate.
There are many formulas for calculating demand accuracy, or demand error, including the Mean Absolute Percent Error (MAPE) and Mean Absolute Deviation (MAD) — see our blog post on calculating forecast error for the specific calculations.
While an enterprise resource planning system may include some forecasting functionality, consider investing in inventory optimization software. An inventory optimization ERP plug-in will not only dynamically forecast your demand, but also provide data on the accuracy of your forecasts and adapt them for future.
3. Backorder rate
This inventory KPI keeps track of the number of delayed orders due to stockouts. It shows the percentage of orders that cannot be filled at the time a customer places them.
A high backorder rate can indicate poor demand forecasting and planning and can obviously affect customer satisfaction. It is simply calculated like this:
If your orders often include multiple lines and shipments, you can also drill down into the actual line orders for more accuracy.
4. Carrying costs of inventory
The inventory carrying costs include all the overhead (much of it hidden) you incur by stocking items in your warehouse. These costs include:
Capital costs — all costs related to the investment in buying stock, e.g. the cost of the stock, the interest on working capital and the opportunity cost of the money invested.
Storage space costs — a combination of the warehouse rent or mortgage and maintenance costs, such as lighting, heating and air conditioning.
Inventory service costs — these include insurance, security, IT hardware and the cost of physically handling the goods.
Inventory risk costs — costs that cover the risk of items losing value whilst stored, shrinkage, or becoming obsolete.
The carrying cost of inventory is calculated by totaling the above overhead contributors and dividing by the average annual inventory cost. Carrying costs are expressed as a percentage, and the values typically range on average between 15–20%.
More efficient warehouse and inventory management processes will help improve this KPI. If you can keep goods moving through your warehouse and avoid excess and obsolete stock, your carrying cost KPI will be in good shape!
5. Order cycle time
Order cycle time measures the time period between placing orders with your supplier (do not confuse this with lead time, which is the time between placing the order and it being received).
By analyzing this KPI you can understand how efficiently you prepare and process orders. If you have efficient processes or automation, you should be able to handle ordering on a frequent basis. The more often you order, the less stock you need to carry, which reduces carrying costs and improves your turnover ratio.
However, replenishment can be restrained by your suppliers’ ordering stipulations in terms of order frequency and minimum order quantity.
6. Rate of return
This simple inventory KPI tracks the percentage of orders that are returned using the formula:
Instinct tells you that you want to keep this KPI low as possible, as it adversely impacts customer satisfaction. However, it’s a well-known fact that in some industries, retail in particular, returns are growing at an increasing rate. For effective inventory analysis, this KPI should therefore be broken down by reason for return (to establish if it’s a quality issue), the incorrect item sent, or simply the result of a growing social trend, etc.
7. Order pick, pack and dispatch accuracy
These inventory management KPIs can be as top level or specific as you require and your systems allow. The process of locating items, packing and shipping them is the core function of most warehouses and therefore monitoring the efficiency of each stage is key to improving productivity.
Pick, pack and dispatch KPIs can reveal where your warehouse processes are especially strong and where they require improvement.
8. Service level
At EazyStock we believe that service level is one of the most important inventory KPIs that you can analyze and track! Here’s why:
Service level measures whether an inventory item was out of stock when it was requested for delivery, leading to an unfulfilled order e.g. whether historical demand (or sales orders) could be met from the inventory on-hand.
Any out-of-stock item, even if it’s just one SKU, will lead to an incomplete order which can be detrimental to customer satisfaction. The service level KPI therefore closely correlates with customer service.
Initially, you should set your desired service level based on how critical the stock item is to your business (how much revenue or profit it makes) and its forecasted demand and level of volatility. For example, profitable products that constantly sell well should have a high service level of around 99%, while unprofitable goods that have intermittent demand could have a lower service level of around 85%. ABC analysis or other inventory classification models can be used for this.
With your service levels set, you then need to track them as order transactions take place and report on the actual figure against the target.
An advanced inventory management tool like EazyStock uses more complex algorithms to set service level targets. Along with the variables above, it also considers the lead time of the SKU, so both supply and demand factors are used to calculate whether orders will be met. EazyStock then uses service level targets to set inventory parameters such as reorder points, safety stock and order quantities to ensure demand can be fulfilled and the risk of a stockout is minimized.
Inventory Management KPIs that Will Optimize Stock Levels
There are many KPIs that you can use to analyze your stock management efficiency, and in this blog post we’ve discussed eight that we see most commonly used.
However, at EazyStock we believe the most important inventory KPIs are those that show how well you’re optimizing your stock levels. Why? Because stockouts and, conversely, excess stock cause a wealth of problems for businesses, from financial concerns to marketing catastrophes.
Inventory optimization KPIs focus your analysis on how well you’re meeting demand while managing stock levels to prevent over and under stocking.
If you’d like to know more about EazyStock inventory optimization software and how it can help support you with inventory KPI setting, tracking and management, don’t hesitate to get in touch.
Originally published at https://www.eazystock.com on January 31, 2022.
