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 complete orders that are on time.
Inventory management KPIs are essential as they help analyse and track the performance of inventory management activities and eliminate guesswork, e.g. how stock is ordered, managed and turned. With a range of inventory management data, you can measure the progress of supply chain objectives and identify areas for improvement so you can make strategic, data-led decisions.
With a wealth of KPIs available to help manage the performance of your processes, how do you choose the right ones for your business? Which are the most important to ensure you’re on the right track to optimum efficiency? Let’s take a look.
Every business is different and will be working toward different targets, but here are some tips for selecting the best ones for you.
KPIs need to be SMART – specific, measurable, achievable, relevant, and timely, so avoid setting targets that are too broad and are difficult to quantify and measure. 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”.
KPIs will influence how employees carry out their jobs, so ensure the metrics you choose will promote the right collaborative behaviour and avoid any that encourage competition between departments.
Don’t forget that once your KPIs are in place, you need to track and communicate regularly across your business. Your business or inventory management system should be able to help with this. Employees need to understand their importance and how they’ve individually impacted performance. Offer praise when you’re performing well and constructive feedback when performance needs to improve to keep everyone motivated towards the same goal.
The Inventory turnover ratio measures how quickly stock is sold and replaced (turned over) in a predefined period, usually a year.
A common way to calculate an inventory turnover ratio is as follows:
Inventory turnover ratio = Cost of goods sold/Average inventory value
Average inventory value = (Opening inventory value + Closing inventory value)/2
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 fulfilment. Read our whitepaper on How to fix inventory turnover challenges for more tips.
The stock-to-sales ratio compares how much inventory you have available to sell versus what you have already sold to check the health of your stock levels.
You can use this ratio to adjust your stock levels so they are continuously optimised to reduce holding costs, improve cash flow, maintain high margins and reduce the possibility of stockouts.
Stock to sales ratio = inventory value/sales value.
The sell-through rate compares the total inventory sold with the total inventory received from a supplier. This can help you understand your demand forecasting accuracy, which we discuss next, highlight popular products, and mitigate storage costs, which all help to understand supply chain efficiency.
Sell-through rate = (units sold/units received) x 100
This KPI analyses how accurate your forecast was against actual sales. The smaller the gap between what was forecasted and what was sold, the more accurate your demand forecasting. Accurate demand forecasts improve your inventory turnover rates and lower your carrying costs.
There are many formulas for calculating demand accuracy, or demand error, including the Mean Absolute Percent Error (MAPE) and Mean Absolute Deviation (MAD), which we explain in more detail in our blog post on calculating forecast error.
If you’re struggling with demand forecasting accuracy due to the limited functionality of your enterprise resource planning system, you should consider investing in inventory optimisation software. An inventory optimisation ERP plug-in will not only dynamically forecast your demand but also provide data on the accuracy of your forecasts and adapt them for the future.
The backorder rate KPI keeps track of the number of delayed orders due to stockouts. It shows the percentage of customer orders that cannot be filled at the time of placing.
If your orders often include multiple lines and shipments, you can also drill down into the actual line orders for more accuracy.
A high backorder rate can indicate poor demand forecasting and planning and affect customer satisfaction. It is calculated as:
Backorder rate = (Number of undeliverable orders/total number of orders)/100
Inventory carrying costs or holding costs, include all the overheads (many hidden) you incur by stocking items in your warehouse. These costs include:
The carrying cost of inventory is calculated by totalling the above overheads and dividing by the average annual inventory cost. Holding costs are expressed as percentages; values typically range from 15-20%.
You can improve this KPI with more efficient warehouse and inventory management processes. If you can keep goods moving through your warehouse and avoid excess inventory and obsolete stock, your carrying cost KPI will be in good shape.
Order cycle time is a valuable inventory management KPI. It measures the time between a customer placing and receiving an order. This isn’t the same as lead time, which is the time between placing and receiving the order – it relates to the customer’s order. The lead time could make up part of the order cycle time.
By analysing 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 frequently. 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 suppliers’ ordering stipulations regarding order frequency and minimum order quantity.
This simple KPI tracks the percentage of orders that are returned using the formula:
Rate of return = (Number of units returned/Number of units sold) x 100
Instinct tells you that you want to keep this KPI as low as possible, as it adversely impacts customer satisfaction. However, in some industries, particularly retail and eCommerce, returns continue to grow.
For effective inventory analysis, you should break this KPI down by reason for return to establish if it’s a quality issue, the incorrect item was sent, or the result of a growing social trend, etc.
These inventory management KPIs can be as top-level or specific as necessary and systems allow. The process of locating items, packing and shipping them is the core function of most warehouses; therefore, monitoring each stage’s efficiency is key to improving productivity.
Pick, pack and dispatch KPIs can reveal where your warehouse processes are robust and where they require improvement.
At EazyStock, we believe that service level is one of the most critical inventory KPIs you can analyse and track as it closely correlates with customer service.
Service level measures whether an inventory item was out of stock when requested for delivery, leading to an unfulfilled order or if the sales order could be met from inventory on hand.
Any out-of-stock item, even one SKU, will lead to an incomplete order, which can be detrimental to customer satisfaction.
Initially, you should set your desired service level based on how essential the stock item is to your business (how much revenue or profit it makes) and its forecasted demand and volatility level. For example, profitable products that constantly sell well should have a high service level of around 99%, while unprofitable goods with intermittent demand could have a lower service level of around 85%. Read our blogs to find out how you can use ABC analysis or other inventory classification models for this.
Once you’ve set your service levels, track them as order transactions occur and report on the actual figure against the target.
An advanced inventory management system like EazyStock uses more complex algorithms to set service-level targets. As well as the variables above, it also considers the lead time of the SKU, using supply and demand factors to calculate whether orders will be met.
There are many KPIs that you can use to analyse your stock management efficiency, and in this blog post, we’ve discussed ten that we see most commonly used. However, ensure you choose the ones that best suit your business needs so you’re tracking useful information that can help you improve your inventory management processes and efficiencies.
At EazyStock, we believe the most important inventory KPIs show how well you’re optimising your stock levels. Why? Because stockouts and, adversely, excess stock cause a wealth of problems for businesses, from financial concerns to marketing catastrophes.
Inventory optimisation KPIs focus your analysis on how well you’re meeting demand whilst managing stock levels to prevent over- and under-stocking. We delve further into six key inventory management KPIs in our eGuide.
To improve this number (or make it easier to manage), use an inventory tracking system to track your inventory levels and sales orders in near real time.