Having the right product for your business is key to its success, but to make things even more challenging it doesn’t stop there – you need to ensure the business has the right levels, too much stock and you’ll need to discount effecting margin, not enough of the right stock and you’re not maximising your sales opportunities.
Inventory accuracy has an effect on various areas of a business. The purchasing department relies on accurate inventory data to trigger the purchase of new product or supplies. Production and planning requires an accurate inventory to plan and schedule production. An inaccurate inventory can cause out of stock items, which result in late deliveries to customers and the potential loss of business.
Inventory is the raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale. Inventory represents one of the most important assets that most businesses possess, because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the company's shareholders/owners. For growing companies, this is an important area to manage. You will find that you either have too much inventory (cash tied up, high storage costs, obsolescence, and spoilage costs), or not enough (lost sales, lower market share). The challenges include forecasting inventory requirements, buying in cost-effective lot sizes, and just-in-time delivery systems.
It is stock turn and its effect on gross margin which has seen the raise of the fast fashion model. A model which has been the long-awaited realisation of “lean retailing" with items produced in small batches and within short lead times. The fast fashion model is a whole topic on its on its own, so what are the most important inventory metrics to measure (these will vary depending on your business model):
- Gross Margin
- Stock Turn
- Units per transaction
- Carrying cost of inventory
- Rate of Return
- Inventory to Sales Ratio
- Back order rate
Gross margin: The gross margin is calculated as a company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, and expressed as a percentage. The higher the percentage, the more the company retains on each dollar of sales to service its other costs and enjoy as profits. Tracking margins is important for growing companies, since increased volumes should improve efficiency and lower the cost per unit (increase the margin). Improving productivity requires effort and innovation, and many companies charge ahead, not realizing that margins are going the wrong way. What you don’t measure probably won’t happen.
Stock Turn: The Stock Turn KPI measures how many times a year your business is able to sell its entire inventory. To calculate inventory turnover, use the following formula:
Cost of Goods Sold ÷ Average inventory
Stock turnover is an important indicator of the efficiency of your supply chain, the quality and demand of the inventory you carry, and if you have good buying practices. Generally speaking, a higher turnover rate is better, while a lower turnover rate suggests inefficiency and difficulty turning stock into revenue. Each sector will have different benchmarks and norms. For instance, a fresh produce supplier will have many more turns than a textile/clothing supplier. To calculate the average days to turn inventory (the number of days it takes to sell all on-hand inventory), use the following equation:
365 ÷ inventory turn
A high stock turn rate compared to industry norms is an indicator of success.
Units per transaction: The Units per Transaction KPI measures the average number of units purchased over a period of time and compares that value to target values. Calculate units per transaction using the following formula:
# of units sold ÷ # of transactions
This KPI provides important data about customer purchase trends, and the effectiveness of your sales teams at moving product quickly. Each sector will have different norms for the number of units per transaction so it's important to compare your values to historic averages and competitors within your sector.
Carrying cost of inventory: The Carrying Cost of Inventory metric measures how much it costs your business to store inventory over a given period of time. Use the following formula when calculating carrying cost of inventory.
Inventory carrying rate x Average inventory value
Every piece of inventory that you purchase and store has some sort of cost associated with it, such as labour, risk/insurance, storage, and freight. This metric is used to figure out how much profit can be made on your current inventory. Low costs and high inventory turnover rates are indicators of success.
Rate of Return: The Rate of Return KPI measures the rate at which items are returned to you. The key to this metric is providing a breakdown for the reasons why items are returned so you can identify trends and reduce your rate of return ratio by addressing issues at their source.
Inventory to Sales Ratio: The Inventory to Sales Ratio metric measures the amount of inventory you are carrying compared to the number of sales orders being fulfilled. Calculate inventory to sales using the following formula:
Inventory value $ ÷ Sales value $
Inventory to sales is useful as an indicator for the performance of your business and is a strong indicator of prevailing economic conditions, and your ability to weather unexpected storms. This metric is closely tied to your inventory turnover ratio and, when taken together, speak to the financial stability of your business. It's important to note that the cost of carrying inventory means you want to sell your inventory as quickly as possible. A low or dropping inventory to sales ratio is an indicator of success.
Back order rate: The Back Order Rate KPI measures how many orders cannot be filled at the time a customer places them. A high back order rate means your customers are forced to wait while you attempt to fill their order, which will adversely affect customer satisfaction and retention in the long term. Monitor this KPI to identify why certain items are not in stock and to deal with trends (such as seasonal demand) that may affect your business performance.
As many of you gear up for your annual stocktake, the importance of inventory management cannot be stressed enough, get this right and your business is on the path to success!