The objective of any inventory management program or inventory system should be to minimize cost, maximize profit while being able to meet customer expectations (orders). Just like in any business discipline tracking, monitoring and measuring metrics is crucial for effective management.
However the metrics you use will drive the performance because you’ll be focusing on the KPIs you measure and that’s what you’ll be managing. The process of picking the right metrics has incredible impact on your success when it comes to managing inventories and the supply chain in general in your organization.
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While every business is unique in some way and it will require some specialized know-how and experience from management, there are some business KPIs and metrics that are general and effective for every company and every business model regardless of the type of the organization.
Here are the 3 inventory metrics you should use on your inventory reporting dashboard – they are very simple and easy to use while they give you the information you need to continuously improve your supply chain management:
1. Inventory Turnover
Inventory turnover is the top inventory metric used by any business. This KPI measures how fast you are moving your inventory. You need to have the COGS and average inventory value in order to calculate this metric.
Here is the formula:
Inventory Turnover = COGS / Average Inventory Value
Inventory Turnover is generally calculated over a 12 month period however you can use (and you should use) this metric over different time periods in order to compare performance. As an example, if you would like to compare Inventory Turnover month by month you can do that by having the COGS for each month and Average Inventory Value for each month.
2. Inventory to Sales Ratio
This simple inventory metric measures the efficiency of your inventory system and supply chain in general. It measures and compares the level of your inventory in relation to your sales volume for the period. It is calculated by dividing your Average Inventory Value for any time period by the Sales of that time period.
Here is the formula:
Inventory to Sales Ratio = Average Inventory Value / Sales
3. Backorder Rate
Backorder Rate measures the rate of customer orders that the company is not able to fulfill because the item ir items orders by the customers are not in stock. In such a situation the company needs to order the items and ship the order with some delays for the customer. Since this drives customer satisfaction and retention as well as lost sales – this is very important metric for your business. Backorder Rate can be calculated by dividing the number of backorders by the total orders for the period.
Formula for Backorder Rate:
Backorder Rate = Number of Backorders / Total Number of Orders
Here are some other examples of inventory metrics which you could consider for your inventory reporting and management.
Inventory Metrics Examples:
Lost sales are important to monitor because your business is losing revenue because the items ordered by the customer are on in stock. This happens when at the time customer places an order you are not able to backorder because the customer is not willing or able to wait any longer and customers have to make a purchase from your competitors. This is critical because one lost sale can result in a lost customer in case you don’t have a relationship with the customer – your competitor can get the customer for life.
This is a metric which measures how much time or how long is required for your organization to fullfil the entire order process from customer placing the order to the final delivery of the products to the customer. You can define this KPI in many different ways based on your supply chain management. For example you can have multiple cycle time metrics measuring different stages in your cycle management process in order to track all the process involved in your system.
Item Fill Rate
This metric monitors the percentage of customer orders that you were able to fulfill in a certain period. This is the difference between total orders one hand and the lost sales and backorders on the other hand. You can use all of these three metrics together on your dashboard.
You should definitely measure the accuracy of your inventory system with periodic inventory counts and measuring the percentage of accuracy at each inventory count. If your actual inventory level is way different compared to your inventory system you should work on fixing and improving your accuracy %. You can focus on more frequent inventory counts on your top selling items and do more frequent sampling in case you need to improve your accuracy.
Out of Stock Items
This inventory metrics measures how many items were out of stock at the time customers placed an order during a defined period. You can calculate Out of Stock Items as a ratio between out of stock items and total number of items in stock.
Carrying Cost of Inventory
Carrying cost of your inventory is the cost associated with managing, holding and storing your inventory over a certain time period. This is generally what most people refer to when talking about cost of inventory however minimizing the carrying cost of inventory is only one of the objectives in supply chain management and this metric should not be monitored in vacuum but it must be reported and tracked along with your other inventory metrics.
Benchmarking is very important for effective inventory management and you should compare your inventory metrics with the metrics of the competitors in your industry. Depending on the type of business and products the values of these metrics will be different – there is no general answer to what is a good item fill rate for example because it varies between industries.
Another reason why there is no general answer for inventory metrics in general is because your targets and objectives will vary based on your strategy – for example one company can pay more focus on minimizing lost orders and backorders while other organization can focus on minimizing the carrying cost of inventory – it all depends on what is your overall business strategy.