How to Measure Inventory Performance with Inventory Management Metrics
Answered July 03 2019
Utilizing key performance indicators (KPIs) throughout inventory control systems helps drive more effective decisions and strategies. With valuable insight from inventory performance metrics, businesses are able to improve cash flow, reduce operating costs, and increase customer satisfaction.
Calculating how fast the inventory is moving provides valuable insight into how efficiently it is managed. While having sufficient stock on hand is crucial to keep your supply chain moving smoothly, purchasing and storing items generate also generate costs. Optimizing inventory levels keeps a healthy balance between managing costs and maintaining enough inventory to sustain operations.
Determining Inventory Performance Metrics to Monitor
It’s important to measure how your business operates, in order to create more transparency into profits over time. If you are coming up with a KPI strategy from scratch, it can be daunting to know exactly which inventory management metrics to assess for your business.
For example, if you own a hardware store, you might first consider measuring whether you have enough stock items on hand to meet the needs of customers. However, let’s say you want to understand the availability of your items. A different metric, such as sell-through rate, could give you a better sense of the percentage of units sold, compared to available units.
We recommend identifying the key functions of your business to determine the best inventory performance metrics to adopt for your business. First, look at what value your business brings to customers.
For example, if you are a freight company, the value you bring is how many containers you have in supply to meet the needs of customers. Quantity in stock, as well as time, are two factors you should consider in this situation. Let’s take a look at examples KPIs to consider for your business.
Difference Between Qualitative and Quantitative KPIs
Just like any other measurements, KPIs can be either qualitative or quantitative.
Qualitative measurements do not have a numeric value and can include things like milestone charts, project plans, and critical analysis.
Milestone charts help businesses and organizations visually illustrate a timeline that shows the schedule and intervals for a major project. These are useful to track progress and plan upcoming steps. Project plans can serve as the primary organizational tool that outlines the individual components with deadlines and necessary labor and resources required. Critical analysis can show the specific path, as well as track completions throughout the process.
Quantitative measurements frequently use formulas to determine starting points, set goals, and track measurable progress toward those goals. Let’s consider six quantitative inventory management KPIs.
Six Quantitative Inventory Management KPIs
While these metrics provide an extended view of the stocking performance of a plant, the number of inventory turns is most commonly used to measure the success of inventory levels.
1. Inventory Turnover
To measure performance in inventory management, one of the most common metrics to use is the “number of inventory turns.” This number is calculated using the ratio of the value of purchased stock to the value of stock on hand. The metric, number of inventory turns, aims to measure the movement of stock. The higher the turnover, the less time your inventory spends sitting in storage.
The number of inventory turns, also known as stock turn, is calculated by taking the value of stock purchased, divided by the value of stock on hand.
Calculating inventory turns
Inventory turns = Value of stock purchased/Value of stock on hand
Where: Value of stock purchased = the total value of inventory items purchased over a period of time and Value of stock on hand = the current value of inventory that is in stock
For example, if over a period of one month the total value of purchases amounted to $5,000 while the current value of stock on hand is $2,500, then inventory turns can be calculated as:
Inventory turns = $5,000,000/$2,500,000 = 2
What is a good Inventory turn ratio? Target value of 1.0
As a rule of thumb, the Society for Maintenance & Reliability Professionals (SMRP) suggests an inventory turn value greater than 1.0 when accounting for the total inventory, and a value greater than 3.0 when accounting for inventory without critical spares.
Note that target values are expected to vary across different industries. Values may also vary depending on the maintenance strategy used by an organization.
2. Stock outs
The metric “stock outs” is the frequency of inventory requests without available stock. Most frequently, stock outs impact the entire supply chain of your business. For customers, it can be extremely frustrating when they have to wait on a business for available products, which can translate into reduced loyalty and business. Some causes of stock outs include failure to consistently manage inventory, or machine breakdowns that lead to delays.
Calculating Stock Outs
The number of stock outs, or frequency of inventory requests without available stock, is measured by taking the percentage of number of stock unable to be supplied in terms of monthly or annual sales volume
In equation form: Stock outs = Frequency of stock outs / Monthly sales volume Or Stock outs = Frequency of stock outs/ Annual sales volume For example, if 300 customer orders were not able to be fulfilled out of 1000 total orders for the month, the monthly stock out percentage would be 30%.
3. Inactive Stock
Inactive stock is the amount of non-critical stock that remains unused over a period of time.
Appropriate levels of inventory, as measured using the number of inventory turns, allow plant personnel to take steps towards lowering costs (reducing spend on unneeded inventory) while increasing operational productivity (preventing stock outs).
4. Lost Sales
Another great metric for your business is lost sales, which looks at the frequency a customer asks for an item, but you do not have it in stock, so they go elsewhere. Factors that are important in this calculation include average daily demand, forecasted amount, and customer demand. Having a strong inventory management program prevents businesses from incurring lost sales over time. However, lost sales happen to even the best of business owners.
Calculating Lost Sales
Average daily demand = Current period seasonalized Forecast / number of days in the period Lost Sales Quantity = Average daily demand X # Days out of Stock
5. Carrying Cost of Inventory
An invaluable metric for measuring how much of a manufacturer’s working capital is tied up in inventory, this metric provides insights into the hard-to-find costs of handling items. These include put-away, costs of obsolescence and how effective warehouse management systems (WMS) are in reducing fulfillment costs.
As discussed in the sections above, comparing carrying cost and inventory turnover with your contribution margins is a great way to see which items are worth the extra time in your warehouse.
6. Order Cycle Time
Order cycle time is the time gap between placing one order and the next order. This metric is also referred to as order lead time, but order cycle time is the more popular iteration. Order cycle time measures the time from when a customer places an order to when they receive their purchased product. This metric reflects how effective your inventory management, supply chain, production and fulfillment operations are.
Order cycle time also sometimes refers to the time between the placement of two back-to-back orders or the successful delivery of two consecutive orders. Regardless of how your company defines these metrics, you should still measure them to get a comprehensive view of your order fulfillment process and where you could improve.
Calculating order cycle time
To calculate the order cycle time, you need to first figure out the time order demand is met, and then figure out backorders.
Time during which demand is met= (Optimal order quantity-optimal amount to be backordered)/ Average demand Backorder time = Optimal amount to be backordered/Average Demand Order cycle = time during which demand is met + back order time
Inventory Management Software Can Help
The key to a meaningful inventory metric is collecting accurate data, and doing so efficiently. Gathering accurate inventory data, while exerting minimal manual effort, is best achieved using inventory management software.
Using inventory management software can keep track of your inventory purchases and usages, as your purchase orders and/or work orders are issued. This relieves individual workers from a lot of manual tracking. This allows for a consolidated database of and easy access to metrics about the flow of inventory.
Effectively Managing an MRO Storeroom
A good inventory management program is critical to being able to effectively manage an MRO storeroom. Best practices indicate that overall inventory accuracy should be 95% of total cycle counts. This requires that all tools and parts are ready to be used as soon as they are needed.
One way to improve the efficiency of a storeroom is to move consumables to the areas where they will be used. For example, safety glasses or protective gloves should be available in multiple areas where employees require them. One study noted that a company estimated they could save $75,000 per year if staff stopped going all the way to a storeroom for batteries.
KPIs outlined earlier in this article including inventory value and turns as well as measures on the accuracy of cycle count and scheduled preventive maintenance compliance can help an MRO storeroom better streamline its work processes and inventory management.
Further Inventory Statistics
Although managing inventory is an important job for many manufacturing and distribution organizations, it's sometimes easy to underestimate the effect that inventory has in our world as a whole. For example, items in inventory as well as in accounts receivable and payable make up about 7 percent of the US gross domestic product alone. In the retail sector, businesses carry about $1.43 in inventory for every dollar of sales.
Inventory management supply chain issues are often top of mind for management teams. For instance, nearly three-fourths of supply chain management professionals believe they can improve their inventory management practices and nearly half hope to reevaluate their warehouse locations.
Automation of inventory management continues to rise with roughly two-thirds of warehouses planning to implement mobile devices in the near future. Studies show that nearly half of all warehouses cite a major issue involving human error.
Dispelling Inventory Management Myths
Many organizations have continued age-old practices when it comes to inventory management because "that's the way it's always been done." However, some of these practices are simply myths and not helpful in making your inventory management system more efficient and effective.
For example, many organizations believe that buying in bulk will reduce costs. In some cases, this can be true. For frequently used consumable items such as paper or cleaning products, buying in bulk can be a good practice. However, components and parts that are replaced or changed infrequently do not benefit from bulk purchases. In fact, the costs of storage and management of infrequently used items can be higher than the bulk savings realized.
Other companies believe that frequent counting of stock can lead to better inventory management and using a simple spreadsheet can track inventory adequately. However, if you're managing many items, physical counting can take several days and manual recording can result in errors. That said, investing in the newest inventory software system may not be the best answer either.
The reality is that while computerized systems can certainly help manage inventory more efficiently, the critical factors are the quality and accuracy of the information. Training your employees on how to update the inventory system properly and why it’s critical on an ongoing basis is really the key to an accurate and complete inventory management system.
This article was updated with more information in May, 2020
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