7 Inventory Management Metrics to Track and Improve Business Operations

by | Nov 11, 2020 | Inventory Management, Order Management, Partners, Retailers

About Guest Author Nick Shaw

Nick Shaw is the Chief Revenue Officer (CRO) of Brightpearl, a leading provider of inventory, warehouse and Omnichannel retail software. He is responsible for Global Marketing, Sales and Alliances for the leading retail inventory management software provider. Nick has written for sites such as Pandadoc and Yieldify. Here is Nick Shaw’s LinkedIn.

By setting key performance indicators (KPIs) to monitor inventory management, businesses are empowered to make better strategic decisions. Tracking the right metrics enables companies to improve cash flow and reduce operating costs — as well as offer world class services to customers. 

But if you’re new to measuring inventory performance, selecting which metrics to focus on can seem like a daunting task. 

The metrics you’ll need to look at will depend on the kind of business you run. If you’re a high- tech retailer, your metrics will look different to those of consumer products retailers, for example. So, first you’ll need to identify your key business functions and examine how you bring value to customers. 

What to consider when selecting inventory management metrics

Before you determine the KPIs you want to measure, bear in mind that your selection will have a big impact on your operations. Inventory metrics can have a bearing on how everyone does their job. So be sure to choose metrics that reward cooperation rather than exacerbate competition between employees and departments. That way, you’ll keep people motivated towards the same goals.

While it’s easier to capture metrics around existing efficiencies, it’s more difficult to gather metrics that reflect increases in effectiveness. However, the latter are more valuable to your business.

Don’t settle for metrics that are too broad in scope because they won’t give you actionable insights. Make your KPIs SMART (specific, measurable, achievable, relevant and timely).

Beware of vanity metrics that, while making a specific department or process appear high performing, don’t deliver useful insights into the effectiveness of your inventory management performance.

Be sure to select inventory software that has a user-friendly and customizable dashboard so you can effectively manage your metrics. And be sure to track and communicate your metrics on a regular basis across the business. Create a chart that can illustrate to employees the importance of these key pieces of data and how they individually impact performance. 

Now let’s move onto some key inventory management metrics to have on your radar:

1. Demand forecasting accuracy

It’s essential to understand how your demand forecasts perform against actual demand so you can close any gaps. This metric also relates to your inventory carrying costs, which are a key element of inventory management effectiveness. 

Accurate demand forecasting means you’re less likely to order excess inventory. Increased accuracy will also enable you to respond quickly when it’s necessary to order more stock than usual — and in the process grow your business. 

2. Perfect order performance

This metric indicates how effectively you’re delivering complete, accurate and damage-free orders to customers. Factors making up a “perfect order” include:

  • The % of orders delivered on time
  • The % of complete orders
  • The % of damage-free orders
  • The % of orders with accurate documentation 

Most suppliers achieve a perfect order performance of 90% or higher. With ever improving manufacturing intelligence, however, perfect order performance is likely to increase further across all production strategies. 

3. Customer satisfaction 

This metric is often measured in terms of net promoter scores or NPS. 

Customer satisfaction levels should be evaluated across both distribution and selling channels, and an NPS score should be determined for each of these, separately. This enables companies to check and index customer order- to-delivery times to see if they’re as they should be, as an example. There’s a big difference between customer service that’s merely good and offering word class services to customers.

4. Inventory turnover

This metric measures the number of times inventory is sold and replaced — i.e. ‘turned over’ — in a specific time period. It’s a good measure of overall business efficiency. Higher turnover generally means greater efficiency. 

However, this doesn’t mean that having a slower turnover is always an indicator of inefficiency. If you sell higher ticket items, they may spend more time on the shelf, but still make good profits for your business. 

The two approaches generally used for calculating inventory turnover are:

  • Sales by average inventory over a specific period
  • Cost of goods sold (COGS) divided by average inventory over a specific time period

How to interpret inventory turnover metrics

If a company has excessive inventory in comparison to sales, this can indicate unexpectedly low sales or poor inventory planning. For example, there may be an excess of stock built up in anticipation of seasonal selling —or some of the stock may be out-of-date. Also, the accounting method used by a business can affect how much inventory is reported and this can skew results. 

When a company sees a low rate of inventory turnover, it may indicate that they have a flawed purchasing system and have bought too many goods. Or that stock has been purchased in anticipation of sales that didn’t materialize due to a shift in demand. This brings with it the possibility that stock will age and become obsolete. 

A high rate of inventory turnover implies the purchasing function is operating well. But this comes with another possibility: that the company doesn’t have sufficient cash reserves to maintain normal inventory levels. 

5. Out of stocks

“Stock outs” relate to the frequency of inventory requests that occur without stock being available. 

This can impact the entire supply chain and is frustrating for customers who have to wait until a company re-stocks their requested items. As such, this can have a big impact on customer loyalty. Causes of out of stocks include poor inventory management or machine breakdowns – or a break in the replenishment order process. 

Calculate the frequency of “stock outs (i.e. how frequently there are inventory requests without available stock) by measuring the amount of stock that’s unable to be supplied on a daily, weekly, monthly or annual sales volume basis. 

For example, if 400 customer orders were not fulfilled out of 1000 orders for the month due to no available stock, the percentage would be 40%. If your numbers are anywhere near as high as this, you will inevitably be experiencing large volumes of dissatisfied customers. 

In addition to taking steps to improve your inventory management processes, it’s important to implement escalation management techniques. 

6. Order cycle time

The order cycle time (OCT) metric measures the average time required to fulfill orders. 

This inventory management metric is sometimes termed order “lead time,” which measures the time from when a customer places their order to the point of their receiving it.

OCT reflects the effectiveness of your inventory management processes from a supply chain, production and fulfillment perspective. 

Companies with shorter OCTs are responding better to customer orders, while those with longer lead times may be experiencing customer dissatisfaction and becoming competitively disadvantaged. 

If you have efficient systems in place around how you prepare and process orders, you will see better results in this area. 

7. Carrying costs of inventory

These include the many overhead costs (often hidden) of stocking items in a warehouse. They include:

  • Capital costs – the costs related to investment in buying stock, interest on working capital and opportunity cost of invested money
  • Service costs – including insurance, IT hardware, security, and the expense involved in handling goods in a warehouse
  • Storage space – these costs include rent of the warehouse, any mortgages on the property, and maintenance costs including heating and lighting or air conditioning
  • Risk costs – related to the costs of covering items that become obsolete, shrink or lose value while stored

Inventory carrying costs are calculated by totaling up the overhead costs and dividing this by the average annual inventory cost. This will give you a percentage usually ranging from 15 to 20%. 

Implementing more efficient warehouse and inventory management processes will improve your carrying cost KPIs.

While the previous list of metrics may seem daunting, you don’t have to implement all of them at once. If you’re new to inventory management, consider starting with inventory turnover. This is a relatively easy metric to track and will give you a good indication of how well your inventory is performing against sales. 

By adding in metrics that suit your business requirements and tracking them over time, you’ll start to see patterns that will help you improve your inventory management processes. This will enable you to improve operations and become a more efficient organization. 

Just as you keep track of your promotions in your 2020 retail calendar, tracking your inventory management metrics will become second nature. 

In order to collect accurate data without excessive manual input, it’s important to use reputable inventory management software. This can help you keep track of your inventory processes and usage, as well as purchase orders and useful metrics around the flow of inventory. 

The benefits of a warehouse management system cannot be overstated in a retail operation. They include offering you the ability to keep an eye on inventory, shipping, returns, demand, and security. They also help to reduce human error and maximize efficiency.

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