Inventory management is a pretty complicated process. It involves tracking all activities from material purchase, production, and storage to sales and delivery. The primary goal of inventory management is to keep customers happy while increasing sales and revenue.
Manually tracking inventory can be difficult for companies with extensive inventories and orders coming in constantly. The most effective way to manage inventory is to use key performance indicators (KPIs) that show how your organization’s performance in specific areas affects revenue and customer satisfaction.
There are numerous inventory management KPIs, but you do not need to measure them to run a successful company. In this article, we’ll go over the most important KPIs to help you optimize your operations.
Inventory management refers to how businesses monitor their stock and decide what to purchase. It enables you in monitoring inventory from the procurement stage to sales; it tells you if you have enough to fulfill customer orders and alerts you when stock is low.
Key Performance Indicators (KPIs) are a set of quantifiable measurements for identifying business performance over a period in a specific area. You can use KPIs to determine the progress and achievement of your business goals, as well as use the insight to improve the operation of your company.
So, inventory KPIs help you collect the data you need to effectively manage your inventory and evaluate its impact on your business performance; sales, turnover, overall profitability, and more. Inventory KPIs provide information on sales, product demand, procurement, customer satisfaction, process success, and other factors.
The key reason for using inventory KPIs is to help you optimize inventory management for increased business profitability. The following are some of the benefits of using Inventory KPIs in your organization:
This inventory management metric reveals the difference between your customers’ actual demand and the demand expected at the factory. With the demand forecast accuracy metric, you can optimize manufacturing operations to limit overproduction and stock shortage.
Another upside of using demand forecast accuracy is that it helps you reduce logistics (inventory carrying) costs. Using demand forecast accuracy allows you to procure items as necessary, preventing you from ordering too small and having to spend money twice as much money to transport inventory.
It also prevents you from ordering too much, so you don’t stock items that stay in your inventory for too long and risk expiry.
Demand Forecast Accuracy=[(Actual Demand- Forecast Demand)/Actual Demand]x 100
When customer satisfaction declines, your chances of losing customers to competitors increase, resulting in a drop in sales. So, measuring your customer satisfaction level is pretty necessary for inventory management.
Customer satisfaction level or score is a measure of your customer’s overall satisfaction with your services, products, and company. This includes the consistency of your company’s products with customer orders, order-to-delivery time, customer service, and more.
The most effective way to determine your customer satisfaction level is to conduct a customer satisfaction survey, which allows customers to rate their satisfaction with your product or company.
Customer Satisfaction Level = (Positive responses/ Total Responses) x 100
Measuring your perfect order performance is important because it significantly influences your customer satisfaction. A perfect order performance indicates that your company is efficient in handling customer orders; there are no damages, inconsistencies, or delays.
The ideal perfect order performance is 100%, which may seem to be a bit high, but a mishap with an order means a potentially dissatisfied customer. Dissatisfied customers can lead to a drop in sales and revenue, as well as a negative brand reputation due to negative reviews.
Performance Order Performance formula:
[(orders delivered on time/total orders)] x (completed orders/total orders) x (damage free orders/total orders) x (accurate orders/total orders)] x 100
The inventory turnover of a company indicates the number of times inventory was sold and replaced over a specific period. A low inventory turnover rate can indicate one of two things: you’re either overstocking (buying more items than demand) or you’re not selling enough.
A high inventory turnover rate, on the other hand, indicates that you are making decent sales and stocking according to demand.
This metric also helps you discern which items in your inventory sell quickly and which aren’t. Your inventory rate determines which items are worth stocking in your inventory and how much to stock over time.
For example, items that are rarely replaced on the shelf should not be stocked in large quantities unless their sale has a significant impact on your bottom line. Items that move quickly, on the other hand, should be stocked in greater quantities.
Inventory turnover rate = ( Cost of goods/ Average inventory value)
Inventory turnover rate = Sold inventory/ Average Inventory
The supplier quality index measures your supplier’s performance in various areas such as item quality, corrective action, delivery quality, prompt response, and more. In more ways than one, the quality of your supplier’s service influences the efficiency of your inventory management.
For example, if your supplier supplies defect-free items but fail to deliver on time, it will most likely influence your delivery time as well. Even if your items are of high quality, customer satisfaction may suffer as a result of order delays.
Most businesses prioritize item quality and deliver quality over other factors when evaluating supplier’s performance. Here’s an example of how to calculate SQI:
Supplier Quality Index = (Item Quality × 45%) + (Corrective Action x 10%) + (Prompt Response x 10%) + (Delivery Quality x 20%) + (Quality Systems x 5%) + (Commercial Posture x 10%)
This metric measures how often orders are returned to you over a specific period. When measuring this KPI it’s also important to identify the reason for the return.
Track Returns: Return Authorization Form Template
A high return rate usually indicates either poor order accuracy or poor item quality. So, naturally, every company strives to keep this KPI low because it potentially represents dissatisfied customers, a negative brand reputation, and a decline in sales.
Rate of return = (Items returned/items sold) x100
Measuring the backorder rate allows you to monitor the number of orders that are incomplete or delayed because items are out of stock. A high backorder rate means an inaccurate demand forecast.
Intuitively, you should keep this KPI as close to zero as possible because it impacts both customer satisfaction and sales. However, even with the best inventory planning and demand forecasting, most businesses experience backorders.
A good backorder practice is to explain the reason for the back order to customers and notify them when the item is back in stock.
Backorder rate = (number of uncompleted or delayed orders/ total orders) x 100
The time it takes for staff to bring in purchased goods and prepare them for sale is referred to as the time to receive them. This metric allows you to track how effective your stock-receiving process is.
Having a long time to receive is not a good idea; it indicates a faulty receiving system and can lead to order delays.
Time to receive = time for stock validation + time to record stock + time to prep stock for storage
Inventory shrinkage occurs when the inventory level is lower than the inventory procured. It measures the disparity between the inventory available and what should be available.
The most common reason for inventory shrinkage is item damage, fraud, or accounting error. You lose money when there’s inventory shrinkage, so keep it low by monitoring inventory levels in comparison to the inventory procured.
Shrinkage = [(Recorded inv]ntory – inventory available)/ recorded inventory]
This KPI calculates the cost of keeping inventory in storage, also known as inventory carry cost. The significant factors in calculating the cost of carrying inventory are insurance, labor, warehouse maintenance, rent (if applicable), and deadstock (unsellable items).
These factors are divided into four categories: inventory service cost (labor cost and insurance), inventory risk cost (shrinkage and deadstock), capital cost, and storage cost (warehouse maintenance and rent).
This KPI is reduced by high inventory turnover because it minimizes warehouse maintenance and deadstock. The chances of carrying inventory at zero are slim to none, but a good range to keep is less than 20%.
Cost of carrying inventory = [(inventory service cost + inventory risk cost+ capital cost+storage cost)/total inventory rate] x 100
Companies use days to sell inventory to monitor inventory turnover instead of inventory turnover rate to have a daily idea of sales.
Most businesses use the information gathered by this KPI to calculate weekly or monthly turnover, which is preferable to waiting a year to find out if you’re making enough sales or overstocking.
Days to sell inventory = (average inventory over given period/ cost of sold items over a given period) x 365
Put away time is the amount of time it takes to receive purchased items from your supplier and store them in your warehouse. Typically, you should begin recording put-away time when you place an order with your vendor.
You also need to factor in the time it takes to perform quality checks on received inventory before storing it in the warehouse.
One major advantage of using the put-away time KPI is that it helps you prevent shrinkage, as misplaced or miscounted items are usually discovered during the putaway process. It also gives you a good idea of your warehouse processes and staff productivity.
In addition, it speeds up the restocking process because you are aware of items that have recently been restocked.
Put Away Time =Total Time Required to Shelve Products in the Warehouse
The fill rate effectiveness as a percentage of all orders measures how well inventories meet customer delivery dates. It measures how quickly your supply chain is; how fast you fulfill customer orders.
A high fill rate effectiveness indicates a low back order rate and a high level of customer satisfaction.
Fill rate = [(total orders- shipped orders)/ total orders] x 100
Gross margin is the amount of money left after deducting direct costs; it’s the overall company’s profitability.
Calculating gross contribution margin using the product, production facility, and business unit is the most effective metric for evaluating overall business unit performance and its impact on production.
The order cycle time measures how long it takes a company on average to complete a customer order. It is the time gap between two consecutive deliveries; the time required to complete one delivery after another has been completed.
Order cycle time reflects the efficiency of your inventory management, manufacturing operations, fill rate and put-away time. If your order cycle time is long, your company’s fulfillment rate is low; if it is short, your company has streamlined its inventory management process to effectively meet customer demand.
Tracking this KPI allows you to identify other metrics that need to be improved and monitored more effectively.
Order cycle time = (delivery time-received time)/ total orders delivered
This is an important KPI to track in inventory management. It assesses the effectiveness of your company’s order processing. The primary reason for using this KPI is that it ensures customers receive exactly what they requested.
Order pick, pack, and ship include the accuracy of all processes that customers’ orders go through before they are sent out for delivery, from receiving the order to locating the correct item, correctly packing the item (protecting fragile items), indicating the delivery address, and handing it over to delivery personnel.
This KPI provides a clear picture of your warehouse processes and employee competency. Low order, pick, pack, and ship accuracy indicates untrained or understaffed warehouse personnel, and inefficient quality assurance processes.
Here’s the formula to calculate order, pick, pack and ship accuracy:
( Accurate orders picked/total order picked) x 100
Keeping track of the right inventory management KPIs allow you to identify your company’s strengths and weaknesses.
You can use the information collected from measuring these KPIs to improve your company’s weaknesses, allowing you to increase sales, improve customer satisfaction, reduce operating costs, and increase overall profitability.
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