5 Crucial Inventory Management KPIs to Look For
‘You can’t improve, what you don’t measure’ – Peter Drucker
In the competitive business world, every business owner today is running in the race of standing out from the crowd of businesses. Hence, it became really crucial for business owners and managers like you to keep track and maintain records of every single strategy or move that is taking you towards the attainment of your business goals.
But now the question arises, how exactly do you measure your performance? Or what can you do as business owners to measure the after-effects of implementing strategies? The solution to this problem highlights the importance of key performance indicators in the modern world.
To define, key performance indicators (KPIs) are the quantifiable measures that can be effectively utilized to ascertain the performance and effectiveness of the strategies implemented to accomplish your business objectives.
Probing further, if you are a businessman, you can always relate to the fact that inventory management has a crucial role in enhancing the growth and profitability of your business. It does not matter if you are from the manufacturing industry or from e-commerce, if you effectively manage your inventory, you can open wide doors of opportunities to grow and expand your business.
To further elaborate, inventory management refers to effectively managing the storage, order, and distribution of the raw material, processed products, or final products in any business. Moreover, KPIs in inventory management assist in providing some of the crucial shreds of evidence that can assist in making the decision-making process more efficient and effective. Hence, in this blog, we will discuss some of the essential KPIs that are used for increasing the efficiency of inventory management.
5 Vital KPIs for Inventory Management
1. Sell Through Rate
Sell Through Rate measures the amount of inventory that is sold in comparison to the total amount of stock that was shipped in the inventory in a given period of time. It is one of the crucial KPIs of inventory management because it assists in tracking the efficiency of the supply chain. Furthermore, it also assists in identifying the frequency with which your inventory turnover occurs.
Now let’s have a look at the formula through which you can calculate the sell-through rate.
- Sell Through Rate = Number of products sold ÷ Total number of products stocked × 100
To comprehend a little more about the formula, let’s look at an example
Hypothetically, your company has a total number of 2000 units stocked in your inventory and you managed to sell 1458 units in 6 months. Hence, the sell through rate of your company for that 6 months can be calculated as
Sell Through Rate = 1458 ÷ 2000 × 100 = 72.9%.
- Key takeaway – As per Shopify, an average company can have a sell-through rate between 40% – 80%, and in reference to our case, 72.9% implies that your company has a relatively very good Sell Through Rate.
2. Inventory Carrying Cost
Inventory carrying costs are the expenses a company incurs related to storing or holding unsold items before their conversion into liquid capital. This can be another effective KPI for inventory management because it can assist your company in estimating the percentage of cost spent on storing and holding stocks in inventory.
After identifying the key factors contributing to the overall expense, you can effectively apply strategies to eliminate or reduce the overspending factors and increase profit margin.
To elaborate, the overall carrying costs of inventory include 4 types of costs that add up to the expense of a business.
- Capital Costs
Capital cost refers to all the costs invested by a company’s owners to increase or improve or add new assets to enhance the growth of inventory.
- Inventory Service Costs
This category includes the sum of all the amounts covering the insurance and expense of inventory.
- Storage Space Costs
This refers to the addition of all the costs related to the rent, maintenance of the warehouse, or inventory. In addition to this, all the utility costs such as lighting or air conditioning is also included in the storage space costs.
- Inventory Risk Costs
This section deals with the coverage of all the expenses to avoid the risk of losing valuable assets. To elaborate, it includes all the costs for products becoming obsolete or the costs of shrinkage.
Moving ahead, below given is the formula for calculating the percentage of inventory carrying cost of your business.
Inventory carrying cost(%) = Sum of all the inventory holding costs ÷ Total value of inventory × 100
Now let’s take a look at an example to understand the formula effectively,
Hypothetically let’s say you have a company whose total inventory value is $30000 and the sum of all the inventory holding costs is $6000. According to that, the inventory carrying cost will be
Inventory carrying cost (%) = 6000/30000 = 20%
Key takeaway – Ideally, the inventory carrying cost should be around 15% – 20% of the total value of the inventory. In reference to our case, 20% is the inventory carrying costs which is perfect according to the ideal requirement.
3. Inventory to Sales Ratio
Inventory to Sales Ratio is a metric to calculate the ratio of cost of inventory with the total amount of sales occurring in the given period of time. It can be calculated on a monthly, quarterly, or yearly basis. To continue, there are multiple KPI dashboard excel templates that are available online to provide free or paid templates to create graphical representations of the KPIs because it is easy to comprehend and analyze the data through graphical representation.
Moving ahead, the inventory to sales ratio can be effectively utilized as a KPI for inventory management as it can assist in comparing the cost of available stock to the total sales which can prevent obsoletion of products in the inventory.
To continue, managing the inventory according to the sales can help in maintaining the balance of the overall expenditure and can assist you in attaining the SMART goals of your business.
Moving ahead, now the question arises of how you can calculate the inventory to sales ratio? To answer the same, the formula to calculate the inventory to sales ratio is
- Inventory to sales ratio = Average cost of inventory ÷ Total net sales occurred in the given period of time
To clear the formula a little bit more, let’s have a look at an example,
Suppose, your inventory stocked products worth $26,000 on average in the last 2 months and you managed to do a net sale of $100,000 in the same period of time. So according to the formula,
Inventory to sales ratio = 26000 ÷ 100000 = 0.26
- Key takeaway – As per the sources, the recommended ratio for the inventory to sales should be 0.16 to 0.25 and according to our example, 0.26 is a little higher than the recommended value. It implies that your company still effectively manages to sell the stock quickly and the distribution process is operating smoothly.
4. Gross Profit Margin Percentage
Gross profit margin is the amount of money a company earns as a profit after selling the finished product in the market. It can be one of the crucial KPIs in inventory management because it can assist in calculating the overall profit margin depicting the growth and efficiency of the business. The higher the gross profit margin the more profit earned by the company.
Moving ahead, the formula for calculating gross profit margin is,
- Gross profit margin = (Total revenue – total cost of goods sold) ÷ Total revenue × 100
To comprehend a little more about gross profit, let’s have a look at an example
Let’s say, your company has generated total revenue of $6 Million by the end of a fiscal year and the total amount of goods sold in the same period of time was $2 million. Hence, by applying the formula
Gross profit margin(%) = (6-2) ÷ 6 × 100 = 66.6%
- Key takeaway – 50 to 70% of a gross profit margin is considered to be healthy in many industries. However, the percentage may vary depending upon the size and efficiency of the company. Compared to our case, your company had a gross profit margin of 66.6% which implies that your company is enjoying quite a healthy margin in the business.
5. Inventory Turnover Ratio
The inventory turnover ratio effectively measures the efficiency of the company in restocking and selling the final products in the market. It is one of the vital financial KPIs of inventory management because it assists in calculating the capability of your company in generating revenue and earning profits. Along with this, it also assists in detecting the ability your company has in turning over the inventory in a certain period of time.
Another closely related KPI, Days Inventory can also be effectively utilized to further convert the ratio into the number of days a company takes to restock its inventory. The lower number of days represents more efficiency of the distribution process whereas a higher number of days depicts that a company is failing to efficiently sell the stock in a given period of time.
Moving ahead, let’s have a look at the formula for calculating the Inventory Turnover Ratio
- Inventory Turnover Ratio = Cost Of Goods Sold(COGS) ÷ Average Inventory
- Average Inventory = (Beginning + Last Inventory Cost) ÷ Number of times inventory was restocked
- Days Sales Inventory = (Average Inventory ÷ Cost of goods sold) x 365
We know it’s a little complex, so let us give you an example for better comprehension,
Let’s assume again, that you have a company and you invested $4000 in the inventory in the beginning and added $6000 again by the end of the year and your COGS for the same year was $200,000. So, by applying the formula,
Average turnover ratio = 80,000(40000+40000)÷ 2 = $40000
Inventory turnover ratio = 200000 ÷ 40000 = 5
To further convert the ratio into the number of days it took to turnover ratio,
Days Sales Inventory = ( 40000 ÷ 200000) x 365 = 73 days approximately
- Key takeaway – For most industries, the ideal inventory turnover ratio should be between 5 to 10. In reference to our case, your company has a ratio of 5 and it will take you 73 days to restock your inventory again which is quite fair in order to earn healthy profits.
To recapitulate, KPIs play a major role in shaping the future of business and effectively tracking the progress or regress of the company. Hence, the above given KPIs can efficiently record the performance of your business against your company’s business objectives and goals.