Having the right inventory on hand at the right time is essential to running a successful business. This complete guide covers everything you need to know about inventory management: what it is, types of inventory management, key metrics to track and inventory management formulas.
Table of contentsÂ
Inventory management, also known as inventory planning or inventory control, is the process of ensuring stock is held at the right quantity, in the right place, at the right time and at the right cost.
Managing your inventory effectively has far-reaching positive impacts on your business. Keeping enough products on hand ensures you can meet demand, provide a positive customer experience and avoid issues like backorders. At the same time, preventing overstocks can help minimise storage costs and avoids problems like spoilage.
So, how do you make sure you have the right amount of inventory on hand to keep your business running smoothly?
This is where inventory management KPIs can help.
Inventory management KPIs are metrics that help you track and make decisions about your stock. Key performance indicators for inventory management can give you useful insights about your customer demand, ordering processes, sales, supply chain and more. They can also help you pick up on issues early, so you can make adjustments before they impact your bottom line.
Businesses typically measure inventory management by tracking metrics across four key areas:
Monitoring metrics across different business areas can be useful for figuring out what’s working well and what needs to be improved. For example, you might discover that your stock levels are appropriate for your customer demand but your delivery times are too long. Or you might find that your recorded inventory levels don’t match what’s on the shelf. Inventory management metrics help you monitor your entire fulfilment cycle, improve processes and ultimately grow your business.
Inventory management sales KPIs tell you how your inventory is moving and how efficiently you’re managing it in relation to sales. Important inventory metrics for sales include:
Inventory turnover rate, also known as the inventory turnover ratio or inventory turn, is a measure of the number of times inventory is sold, used or depleted in a certain period, such as a financial year. This inventory KPI tells you whether you have an appropriate amount of stock on hand compared to how much you’re selling.Â
You can compare your inventory turnover rate with averages for your industry or historical data for your business. A low inventory turnover rate could signal weak sales or too much inventory, while a higher rate is a sign of strong sales but could also indicate inadequate inventory levels.
Inventory turnover rate = cost of goods sold / average inventory value
Days on hand (DOH), also known as the days to sell inventory (DSI) and days inventory outstanding (DIO), shows the average number of days it takes for inventory to turn into sales. The average varies from industry to industry, but generally a lower DOH is preferred, as it indicates optimal inventory management.
Days on hand = (average inventory for period / cost of sales for period) x 365
Weeks on hand (WOH) shows the average number of weeks it takes for inventory to sell. Like Days on Hand, a lower WOH generally shows efficient inventory management while a higher WOH can signal too much stock or other problems.
Weeks on hand = (average inventory for period / cost of sales for period) x 52
The stock to sales ratio measures the amount of stock on hand compared to the number of sales being made. A lower ratio is typically preferred but a higher ratio can sometimes be expected, such as when a business is growing quickly and needs additional inventory on hand to meet growing demand.
Stock to sales ratio = $ inventory value / $ sales value
Sell-through rate measures the amount of inventory you’ve sold compared to the inventory you’ve received, usually over a month. It helps determine how efficiently your supply chain is operating.
Sell-through rate = (# units sold / # units received) x 100
Backorder rate calculates the number of orders that can’t be immediately fulfilled as a percentage of total orders over a certain period. This metric shows how well you are meeting customer demand and keeping products stocked. Generally, a lower backorder rate indicates efficient inventory management.
Backorder rate = (# delayed orders due to backorders / total # orders placed) x 100
Accuracy of forecast demand is a percent of how close the on-hand quantity of inventory is to the forecasted demand. It shows how closely the predicted demand for products matches the actual demand.
Accuracy of forecast demand = [(actual – forecast) / actual] x 100
Product sales, also known as sales revenue, calculates the income from customer purchases minus any returns or cancelled sales, over a specific period such as a month or year.
Product sales = gross sales revenue – sales returns – discounts – allowances
Average revenue per unit (ARPU) measures how much revenue you’re generating on average from selling one unit of inventory. It can also be used to measure how much revenue a business is generating per subscriber or user, for subscription-based businesses.
Average revenue per unit = total revenue for period / average units sold for period
Cost per unit calculates how much it costs to produce or buy and deliver a single unit of a product to an end consumer. This metric is particularly useful for businesses that produce or sell large quantities of the same product.
Cost per unit = (fixed costs + variable costs ) / # units produced
Gross margin return on investment (GMROI) shows how much revenue is being earned compared to how much is invested in inventory purchases. It can give you a picture of how well you’re able to turn stock into cash, minus the cost of buying inventory.
Gross margin return on investment = gross margin / average inventory cost
Inventory receiving KPIs, also known as warehouse KPIs, measure how efficiently you receive and store inventory. Important receiving KPIs for stock management include:
This measures the rate at which your business brings in new stock and prepares it for sale. Time to Receive shows the efficiency of your stock receiving process, with a lower number indicating greater efficiency.
Time to receive = time for stock validation + time to add stock to records + time to prepare stock for storage
Put Away Time measures how long it takes your business to store stock. A lower number indicates more efficient processes.
Put away time = total time to store received stock
Supplier Quality Index (SQI), also known as Supplier Quality Score (SQS), evaluates how well a supplier meets your expectations against various criteria. Generally, each variable is given a weighted score to calculate an average, for example:
Supplier quality index = (product quality x 45%) + (prompt reply x 10%) + (delivery quality x 30%) + (quality assurance processes x 15%)
Operational inventory KPIs tell you how well your business is running in relation to inventory-related processes. Important operational KPIs include:
Lost sales ratio shows the average number of days a specific product stays out of stock compared to the expected rate of sales for that product. A high lost sales ratio indicates that you may not be keeping enough stock on hand to meet demand.
Lost sales ratio = (# days product is out of stock / 365) x 100
Perfect order rate measures how many orders are shipped without issues like delays, damage or errors over a period such as a month or year. A higher perfect order rate demonstrates efficient processes and that a business is providing an excellent customer experience.
Perfect order rate = [(# orders delivered on time / # total orders) x (# orders complete / # total orders) x (# orders damage free / # total orders) x (# orders with accurate documentation / # total orders)] x 100
Inventory shrinkage calculates the amount of stock a business should have on hand but can’t account for. Shrinkage can result from damage, spoilage, theft or inaccurate inventory tracking.
Inventory shrinkage = recorded inventory value – physically counted inventory value
Average inventory measures the average value or amount of inventory a business has on hand over a given period, such as a quarter. Average inventory values can be consistent throughout the year, or can change for businesses whose sales fluctuate seasonally.Â
Average inventory = (total inventory month 1 + total inventory month 2 + total inventory month 3) / 3
Inventory carrying costs, also known as holding costs, are the costs to store and hold inventory until it’s sold to the customer. This includes warehousing, insurance, rent, labour and the cost of any products that can’t be sold. A lower inventory carrying cost generally indicates a financially efficient business.
Inventory carrying costs = [(inventory service costs + inventory insurance costs + capital costs + storage costs) / total inventory value] x 100
Order fill rate measures the percentage of orders you fulfil without any backorders or stockouts. A higher order fill rate signals that you’re efficiently meeting customer demand.
Order fill rate = (total orders shipped / total orders placed) x 100
Order cycle time (OCT) is the average time it takes for a business to fulfil an order, from the time the customer makes the purchase through to delivery. It demonstrates the efficiency of a business’ fulfilment process, including picking and packing, shipping and delivery.
Order cycle time = (time customer received order – time customer placed order) / # total shipped orders
Stock-outs, also known as out-of-stock items, is the portion of products not available to ship when a customer places an order. This KPI shows a business’s ability to meet customer demand.
Stock-outs = (# items out of stock / # items shipped) x 100
Lead time measures the time it takes for a customer to receive a product after they order it. This metric helps evaluate the efficiency of a business’ entire supply chain, including inventory tracking, order processing, shipping and delivery. A lower lead time signals a well-run business.
Lead time = order process time + production/dispatch lead time + delivery lead time
Dead stock refers to products that are unlikely to ever sell due to spoilage, becoming obsolete or other reasons. Monitoring the percentage of dead stock is important because it shows how efficiently a business is selling or using inventory, and whether or not there is ongoing demand for its products.
Dead stock = (amount of unsellable stock in period / amount of available stock in period) x 100
Available inventory accuracy shows the difference between the recorded inventory levels and what is actually on the shelf. Lower accuracy can demonstrate errors in the inventory tracking process or loss due to theft or other causes of shrinkage.
Available inventory accuracy = (# counted items that match record / # counted items) x 100
Employee KPIs measure the efficiency of your staff in relation to inventory management and order fulfilment. Important employee metrics for inventory management include:
Labour cost per item, also known as unit labour cost, shows how much you’re spending to procure/ produce and sell one unit of inventory. This KPI includes staff wages and any additional labour costs related to order fulfilment.
Labour cost per item = # total units of inventory / total labour expense
Labour cost per hour is a general measure of how much an employee costs a business on an hourly basis. This KPI can be used to track the hourly cost of labour related to inventory management and order fulfilment, such as warehousing staff.
Labour cost per hour = (employee annual gross salary / # weeks employee works in a year) / # hours an employee works in a week
Inventory tracking can be time-consuming, especially for small businesses. QuickBooks helps you effectively manage your stock, so you always know what you have and what you need before you even need it.Â
Track inventory on hand, get alerts for reorder levels and get insights on what you buy and sell with QuickBooks’ inventory management tracking software.
Sign up for our quarterly newsletter and receive educational and interesting content straight to your inbox.
Want more? Visit our tools and templates!
