8 Inventory Management KPIs Every Company Needs To Track
What are Inventory Management KPIs?
Inventory management involves the ordering of supplies, and storing, utilizing, and selling product stocks. It entails the handling, processing, and storage of both raw and finished goods.
Inventory management, in this regard, is related closely to supply chain management, and takes into account the movement of commodities from producers to storehouses, and ultimately to points of sale. The quantities of each item should be accurately counted and records maintained as it enters or exits a warehouse or point of sale (POS). Inventory management is necessary for organizations of all shapes and sizes. It provides organizations with a strong foundation for their business activities.
However, it's not simply enough for an organization to carry out a task. It needs to determine how well the task is being carried out. It's important to ascertain if the measures undertaken by the organization are allowing it to achieve its inventory management goals. This knowledge helps the organization fine-tune its decision-making.
Inventory management activities, therefore, must be measured in terms of certain key performance indicators (KPIs), such as inventory turnover rate, inventory holding costs, cost of goods sold, perfect order rate, sales ratio, lead time, and other quantifiable metrics.
Organizations are able to improve processes for buying and production, and also enhance their profitability and cash flow by using inventory management KPIs. These metrics are crucial for gauging the success of supply chain goals and identifying scope for improvement. Inventory KPIs guarantee that there is always adequate inventory on hand to meet consumer demands and that supply shortages can be quickly addressed.
Why are Inventory KPIs Important?
By leveraging inventory management KPIs, businesses are able to gain valuable insights, which inform their strategies. Decisions can, therefore, be more data-driven, and as a result, both oversupply and undersupply can be avoided. While oversupply pushes storage costs higher, supply shortfall blocks sales opportunities. Both ways, cash flow gets choked.
However, metrics like turnover rate, sale-through rate, stock-to-sale ratio, backorder rate, holding costs, inventory shrinkage, and demand forecast accuracy help businesses gain a fair idea of how much to buy and how much to stock. Some of these metrics will be considered in detail in the subsequent sections. By consistently hitting its inventory management KPIs, a restaurant ensures it never runs out of ingredients for its most popular dishes, and keeps its customers happy. It can also ensure it is not saddled with dead stock that's unlikely to sell and rots on the shelves.
If supplies purchased far exceed demand, resources will be wasted and the organization will be financially hit. For restaurants, this adds to the already massive food wastage problem in addition to driving up food costs.
By monitoring the performance of inventory management and supply chain management activities through the application of inventory metrics, an organization is not only able to enhance its sales and revenue, but can also increase employee and operational efficiencies.
In this regard, employee metrics like labor cost per product, and labor cost per hour, and operational metrics like the number of orders that an organization can fulfill without having to exhaust its supplies, or the time taken to fulfill an order are to be considered. Careful analysis of inventory KPIs will tell an organization where it is spending too much, and how it can cut operating costs.
Inventory KPIs also let companies efficiently manage supply chain issues. By determining whether the right products are being supplied in the right quantities at the right time, organizations can ensure better vendor management, and choose suppliers that offer the most benefits.
Metrics like customer satisfaction score and service level show how well the organization is serving its customers, and how well it is managing its brand image.
Supply Chain Market to Double: The worldwide market for supply chain management is set to almost double over a span of six years, moving from $15.85 billion in 2020 to $30.91 billion in 2026, a Statista report said.
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Tips to Help You Select Your Inventory KPIs
The best inventory management systems are backed by a prudent selection of inventory KPIs. Determining which inventory management indicators to select when developing a KPI strategy is a challenging task.
For instance, for a store selling POS hardware, lead time, or the time taken to deliver a product after an order is placed is an important metric to consider. A restaurant, on the other hand, may prioritize demand forecast accuracy and inventory shrinkage rate.
Inventory KPIs must be SMART, which is to say that they should be specific, measurable, achievable, relevant, and timely. They should not be too broad and abstract, and difficult to measure. In other words, they shouldn't be pie-in-the-sky projections. Therefore, a good inventory management KPI should not merely look to increase stock turnover, it should look to increase it by a specific percentage within a specific time period.
Make sure that each KPI advances the strategic objectives of your company, whether they relate to Inventory Optimization, revenue growth, or customer service.
Remember that once the KPIs are chosen and established, they must be monitored and communicated throughout the organization. Employees must be aware of their significance and how each KPI has shaped the performance of the company. To keep your employees motivated and geared toward the same objective, praise them when they perform well and offer feedback when they need to improve their performance.
It is important to ensure that the KPI you choose does not merely boost efficiency, but also increases effectiveness. It is imperative for inventory KPIs to be in sync with the mission and objectives of the organization. See to it that the KPIs are dynamic, that they give you the exact information you seek, and help identify areas that require improvement. An organization must also find out how their inventory KPIs influence collaboration and competition among the employees, and how the employees can make use of the insights derived from these KPIs.
8 Inventory Management KPIs - No. 1 Inventory Turnover Ratio
This inventory management KPI gauges how often a product is sold over a period of time and is used to determine the efficacy of an inventory management system.
The inventory turnover ratio is calculated by dividing the cost of goods sold by the average inventory value. The average value of inventory, in this regard, refers to the average sum of the opening and closing value of inventory.
The ideal situation is for a business to not have more stocks than it can possibly sell. In case the inventory turnover rate is low, unsold inventory and dead stock tend to pile up and exert pressure on the company's finances. Higher inventory turnover rates, on the other hand, point toward increased efficiency.
Be cautious, though, not to merely reduce inventory levels throughout the warehouse in order to boost the turnover rate because lower stock levels could dent your chances of effectively fulfilling orders.
KPI No. 2 Demand Forecast Accuracy
Forecasting Inventory levels is a vital task carried out by organizations to prepare for demand surges and declines. The more accurate the forecast, the greater the ability of the organization to undertake inventory optimization and inventory control. Accordingly, with quality demand forecasting, a restaurant can buy only as much as is necessary to meet projected demand, avoiding both food wastage and stockouts.
Demand Forecast Accuracy, in this regard, is an inventory KPI that measures the degree to which the actual stock level on hand differs from the projected stock level. It is calculated as a percentage of the actual stock level. Demand forecasts examine what a business predicted, ordered, and sold within the prior time period.
Demand forecasts can be made on the basis of qualitative data. These factors are not exactly measurable and relate to morale, perception, attitude, tastes, and motivation. Thus, a restaurant may expect a decreased demand for meat products due to a growing preference for vegan food and plant-based proteins among consumers.
However, demand and sales forecasting based on hard numbers that factor in historical data, sales patterns, and seasonality tend to be more accurate.
Demand forecasting can be effectively handled by dedicated software like Zip Forecasting, which works in concinnity with the POS and inventory management systems. The Zip Forecasting solution can be downloaded from the Hubworks app store.
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KPI No. 3 Backorder Rate
The number of orders that are delayed owing to stockouts is monitored by this inventory KPI.
Backorder rate refers to the percentage of customer orders that a company cannot fulfill at the time these orders are placed. It is calculated by dividing the number of orders that are undeliverable by the total number of orders and then multiplying the result by 100.
Backorder rate shows how well an organization is able to stock products that are high in demand. Although this figure should ideally be zero, or at least close to zero, weak demand planning and forecasting would lead to stocks running out, and hence, a high backorder rate.
It would not be good for organizations to have high backorder rates as it would affect customer satisfaction and brand equity. However, despite the Best Inventory planning system, products can still go on backorder as a result of unexpected demand spikes and supply chain bottlenecks. It is advisable in such a situation to continue to sell on backorder, instead of foregoing sales and revenue opportunities.
However, customers must be given a clear idea about when they can expect to receive their orders. Organizations forced to sell on backorder must not renege on the delivery date.
Stockouts and backorders can be prevented by monitoring inventory in real time, setting reorder points, and automatically placing orders when stock levels deplete. These objectives can be achieved with the help of quality inventory management software from Zip Inventory, which also comes from the Hubworks supply line. Some organizations make sure to maintain safety or buffer stocks to cushion the effect of demand surges, or supply chain disruptions.
KPI No. 4 Order Cycle Time and Lead Time
Order cycle time refers to the time that a company takes to produce an item. It essentially extends from the start of production to the end of production and ultimately, delivery. Lead time, on the other hand, is a wider concept that measures the time between the placement of an order and the receipt of that order by the customer. Lead time subsumes order cycle time. Lead time can essentially be calculated by adding up the time taken to process, prepare, and deliver an order.
Let's understand this with a restaurant example. Assume that you place an order on a third-party app at 10.30am. The order is instantly passed on to the restaurant POS. As the order is recorded in the restaurant POS system, it flashes on the kitchen display screen so that the chefs can quickly start preparing the food. However, the restaurant is seeing heavy traffic at that moment and the chefs are inundated with a pile of orders. It consequently takes more time than usual to start preparing your meal. Let's say the chefs start preparing your meal at 10.45am.
The preparation finishes at 11.15am, and the food is delivered to your doorstep by 12noon. Now, this entire one-and-a-half hour period (10.30am to 12noon), from when you placed the order to when you received it, constitutes the lead time. Order cycle time, however, would be counted from the time the food preparation starts, that is 10.45am. Accordingly, the order cycle time would be 1 hour and 15 minutes.
The most common causes of extended lead and order cycle times are stockouts, delays in shipping and receipt of supplies, and mismanaged business processes. Organizations can derive a lot of advantages by shortening lead and order cycle times. It pleases customers to have their orders delivered quickly. Organizations can also avoid inventory from unduly building up in the store.
KPI No. 5 Carrying Costs
Inventory holding costs or carrying costs refer to the overhead expenses incurred by stocking goods. These are in the form of capital costs, storage space costs, inventory service costs, and inventory risk costs.
The cost of inventory, interest on working capital, and the opportunity cost of the investment make up capital costs. Opportunity cost, in this regard, refers to the potential profit forgone by choosing one alternative over another.
The cost of the storage space includes costs incurred on warehouse rent, mortgage costs, and costs on maintenance, like lighting, air conditioning, heating, and so on.
The expenses on insurance, IT hardware, security, and physical handling of stocks constitute inventory service costs. Risk costs refer to the expenses incurred to address the risk of commodities losing value while being stored.
Adding up all these overheads and dividing the result by the average yearly inventory cost would give you the inventory carrying cost. It usually varies between 15-20%.
Efficient warehouse management, moving inventory through the warehouse, and avoiding obsolete and excess stocks will help an organization perform well on this inventory metric.
KPI No. 6 Average Inventory
This measures the stock level that an organization holds at any given time. The objective of this KPI is to see how well prepared businesses are to deal with sudden demand surges, fall in inventory levels or supplies, and how efficiently they can ensure a constant flow of stocks to meet their needs. The formula to calculate average inventory can be represented thus-
(Beginning stock level + ending stock level) / 2
The concept of safety stocks has been discussed earlier. Safety stocks ensure that businesses always have enough inventory on hand so that customers don't have to be turned away. This insurance against stocks running out makes sure that the Inventory Control is robust and the customers are not antagonized.
A concept related to average inventory is stock availability. It shows the amount of inventory a company has for selling. A company that is unaware of its average inventory and stock availability will invariably see costs on logistics going up, and profits getting thinner. By knowing your average inventory and stock availability, you are also able to make better demand and sales projections, and this, in turn, ensures efficient inventory optimization.
To have a complete idea of your available inventory, you must have inventory visibility. This can be ensured by inventory management software that tracks inventory in real time and conducts automated inventory audits.
KPI No. 7 Inventory Accuracy
Inventory accuracy matches the stocks on your shelves with that in your records. Poor inventory accuracy may result in stock wastage, stock shortfall, and ultimately, loss of money.
Inaccurate inventory counts are generally prevented by sophisticated inventory management software like Zip Inventory, but it's always better to back this up with a physical head-count of stocks.
While ensuring inventory accuracy, businesses should also focus on preventing inventory shrinkage. This usually results when the actual stock level is less than what had been accounted for. It points toward accounting/counting errors, or misplaced/damaged/stolen stocks.
KPI No. 8 Perfect Order Rate
An order fulfilled without any problems, returns, or delays is termed a perfect order. The rate of perfect order can be calculated thus-
Perfect rate of order = [(number of orders delivered on time + orders completed + orders free from damage + orders that are accurately documented)/ total number of orders] x 100.
Alternatively, the rate of perfect order can be measured by using the following formula-
Perfect rate of order = [(total number of orders - failed orders)/ total number of orders] x 100.
The aim of an organization should be to have as high a perfect order rate as possible. The higher the perfect order rate, the greater the customer satisfaction, and higher the profit.