One great reason to consider an inventory management system is to help your small business keep your inventory carrying costs down. But how do you know if you’re inventory management process is making your business more efficient and saving on costs over time?
We’ve put together a list of four crucial metrics that you should keep a close eye on over the course of the year: inventory turnover, average days to sell, return on investment, and inventory carrying costs. Tracking metrics can help you make decisions about scaling your business, forecasting sales, and identifying opportunities to hone your supply chain operations.
1. What is inventory turnover?
Inventory turnover is the amount of times your inventory is sold and replaced over a certain time period (like a year), letting you know how your business is performing.
To calculate inventory turnover, divide cost of goods sold (COGS) by average inventory for your specific time period. Use average inventory to take seasonal fluctuations in sales into account. COGS can include cost of materials, labour costs directly related to producing goods, and any factory overhead or fixed costs associated directly with production.
Generally, a higher inventory turnover rate means you’re enjoying brisk sales. A low inventory turnover suggests that you could be ordering too much and it may be time to revise your ordering or production strategy.
You can calculate your inventory turnover rate for your entire stock, or just for a specific SKU so you can tell if specific items are selling faster or staying on your shelves longer.
2. What is average days to sell inventory (DSI)?
The average days to sell inventory (DSI) helps you put a figure on your inventory turnover. You’ll know how long it takes for you to sell your inventory each months, and it’ll also show how many days sales of inventory you have on hand at any given time.
Calculate DSI by dividing your average inventory by cost of goods sold. Multiply the result by 365.
Generally, a lower DSI is better because that shows that your inventory isn’t gathering dust in your warehouse for too long before being sold. However, if your average days needed to sell inventory is too low, you have the risk of running out of stock.
On the other hand, if you’re taking a long time to sell your inventory, you could be carrying too much slow-moving stock that is on the verge of turning into dead stock.
Different industries can expect different DSI. If you’re selling fresh foods, your DSI is likely to be a lot lower than if you’re selling furniture or other higher cost items.
3. Return on investment (ROI)
Calculating your return on investment (ROI) is an easy way to know how well your business is doing. You’ll know if you’re making a profit, and how much it is. And once you know how well your business is doing, you’ll be able to decide how much of your profit should be reinvested into the business to boost future growth.
To calculate your return on investment in your inventory stock, first subtract gain from investment (profit) from cost of investment. Divide the result by the cost of investment. Then multiply that total by 100.
Your cost of investment doesn’t just cover how much you’ve spent purchasing inventory, but also includes your inventory costs and the carrying costs attached to your inventory.
4. Carrying costs
Carrying costs include:
- Opportunity costs of investing in inventory.
- Storage costs for facility maintenance.
- Inventory service costs covering insurance and software applications.
- Inventory risks costs when shrinkage and obsolescence happen.
You need to keep your carrying costs at about 25% of your inventory value. If you want to reduce your expenditure on the carrying costs, you can start by reducing the size of your inventory.
To calculate carrying costs, use this formula:
Total inventory value/ Average annual inventory costs = Carrying costs
When it comes to keeping track of your costs and your sales, inventory management software can be a great help. With inventory management software, you’ll be able to generate sales reports, which can offer useful insights when you’re calculating key success metrics.
At some point in your inventory management journey, you might find that your inventory needs are complex enough that it’s time to make the move to a scalable inventory management solution. If you’re wondering about when’s the right time, check out this article on how to decide when it’s time to upgrade.