Inventory management is a delicate dance. Carry too much of a slow-moving product, and you risk running up your carrying costs. Carry too little of a popular product, and you risk stocking out and losing customers. It can also be a real challenge to get the visibility you need — into your inventory levels, the supply chain, and fluctuating customer demand — to avoid those extremes.
This underscores the need for close measurement of your inventory management performance. Your business can establish reasonable baselines and realistic goals by tracking the right KPIs. It’s virtually impossible to optimize a process as tricky as inventory management on instinct alone; decisions should be made based on data.
Here are eight key performance indicators your organization needs to track to manage inventory properly:
This KPI measures your inventory management efficiency. By dividing the cost of goods sold by your total inventory, you can see how many times your inventory turns over during a specific period. A lower ratio indicates that you may be buying and holding too much product, driving up storage and carrying costs in the process.
This is similar to inventory turnover ratio, but instead of dividing your inventory by the cost of goods sold, you divide it by net sales. If you have a high turnover ratio and a low inventory to sales ratio, that means your company is doing a good job of selling inventory quickly and efficiently.
GMROI takes inventory efficiency metrics one step further by measuring the actual profitability of your company’s inventory management practices. By dividing your gross profit by your average inventory cost, you can determine how well you turn inventory into cash. The higher your GMROI, the more profit your inventory is generating.
Without accurate recordkeeping, it’s hard to make informed business decisions. Measuring your inventory accuracy rate involves counting units of a particular product and comparing it to your recorded count. A consistent 100% accuracy rate isn’t realistic, but you want to get as close as possible. If you notice your rate slipping down below 97% or so, you may need to improve training, warehouse processes, or both.
This metric captures your company’s ability to meet customer demand with its current inventory. In the past week (or month or quarter), what percentage of orders were you able to fulfill right away? As with inventory accuracy rate, the ideal order fill rate is 100%, but you should expect it to be a bit lower than that due to the sometimes-unpredictable nature of business. If you’re far below that figure, you’ll need to set realistic fill-rate goals and build toward them with improved processes.
The inverse of your order fill rate is your backorder rate. This is the percentage of orders that couldn’t be fulfilled right away with your existing inventory. Backorders are inevitable for even the most well-run organizations, but if your typical rate is too much higher than 0%, that’s a sign that performance needs to improve.
Carrying costs are unavoidable, but if they get out of control, it can be a major sign that your inventory management practices need to improve. When calculating your overall inventory carrying cost, you should factor in capital, freight, storage, labor, insurance, and any obsolete stock you may have. Keeping track of each individual factor can help you pinpoint areas that can become more efficient or require some measure of cost-cutting.
Sometimes customer demand for a product wanes so drastically, whether due to an emerging new product or some other reason, that the product becomes obsolete. The obsolete inventory percentage is calculated by dividing the value of unneeded items by the total value of your inventory. If you’re caught with more obsolete items than your typical competitor, you could be at a major disadvantage, as you may have to eat those costs. In any case, you should track obsolete inventory regularly to clear out space for items that have a chance of selling.
Continuous improvement requires continuous performance tracking. If you wait until the end of the year to figure out how well your company does with inventory management, you’ll find you’ve already missed opportunities to become more efficient and grow.
A modern ERP solution like Microsoft Dynamics 365 Business Central can make it simple to track these and other inventory-related KPIs so that you can detect lagging performance before it becomes a bigger and costlier problem.
At Enavate, we know what distributors need from their ERP solutions, and we not only help with the implementation process but also provide the post-launch support necessary to get the most out of its advanced business intelligence features. Watch our recent webinar or reach out to our expert team today to learn more.