Tracking KPIs related to inventory isn’t just for warehouses or distribution businesses. It’s vital for any small business involved in making, selling, or handling physical products.
Small manufacturers and retailers alike depend on accurate inventory data to manage buying, making, and planning when to make more products. But what data exactly should you be looking at?
Below, we look at nine important inventory management KPIs and offer tips on how to apply them effectively.
How to pick the right KPIs to track?
Picking the right inventory management KPIs can turn wasteful practices into streamlined and effective processes.
However, with dozens of metrics available, deciding which ones to focus on requires some thought.
Some KPIs might fit your business or industry better than others. Retailers often look at things like how fast items sell, discounts given, or profit made from inventory (GMROI). Manufacturers, on the other hand, should pay more attention to how long it takes to make products, the inventory still being made (WIP), or how much of their production capacity they’re using.
For managers who carefully select the most appropriate KPIs for their needs, creating a straightforward dashboard or integrating trackable metrics into their chosen inventory management software (IMS) or warehouse management software (WMS) should be enough to give a clear overview.
So, what options for useful KPIs do you have?
Top 9 inventory management KPIs
Here are the top nine inventory-related KPIs to consider adding to your performance dashboards.
1. Average inventory level
Kicking off with the basics, the average inventory KPI calculates the typical amount of stock you hold at any time.
Average inventory = (beginning inventory value + ending inventory value) / 2
It’s mainly a starting point for working out other measurements, but it also gives a straightforward view of your mean stock level over the financial year.
Generally, all businesses strive to maintain a steady average inventory.
2. Order lead time (order cycle time)
For small businesses and manufacturers, understanding order lead time – or how long it takes from when a customer places an order to when they get their product – is essential.
This measure helps you see how well you’re managing your stock and getting products to customers.
It includes different types, like how long it takes to make a product, get the materials, or deliver it. This insight is crucial no matter if you’re making the goods or shipping them.
Note: Don’t confuse this with how long it takes to complete just one part of making your product. Order lead time also ties into other important measures, like how long it takes from first talking to a customer to making a sale, and how quickly your suppliers get goods to you.
3. Inventory turnover rate
The inventory turnover ratio tells you how often you sell out of your inventory. Essentially, it shows what percentage of your total stock you’ve successfully sold within a certain timeframe.
Inventory turnover rate = number of units sold / average inventory
By keeping an eye on this KPI, you get a clear picture of how your sales stack up against your inventory levels.
It’s an effective way to check if your sales figures and inventory are in balance. Generally, a higher turnover means lower storage and operation costs since products aren’t sitting unused, reducing unnecessary expenses.
To figure out your inventory turnover rate, you can either divide the total units sold by the average inventory or divide the cost of goods sold (COGS) by the average inventory value.
4. Days sales of inventory (or, inventory days on hand)
This KPI measures the average duration your stock takes to sell, indicating how long your cash is tied up in inventory.
Days sales of inventory = time period / inventory turnover
A lower DSI is generally seen as more favorable as it means quicker turnover and, among other benefits, serves as a useful gauge for the risk of running out of stock. It offers valuable insights for determining the ideal amount of stock to keep on hand and improving the accuracy of demand forecasts.
5. Carrying cost of inventory
This KPI is expressed as a percentage, and it covers all the overhead expenses from keeping stock in your inventory.
The goal is to keep it as low as possible while still managing all necessary expenses. The carrying cost includes several types of costs:
- Capital costs – includes the cost of buying inventory and the costs related to the investment;
- Inventory risk costs – costs associated with inventory loss, such as shrinkage or decreased market value;
- Storage space costs – for storing inventory, like warehouse rent, mortgages, and utilities;
- Service costs – expenses for insurance, handling, warehouse security, and similar services.
The formula for calculating the carrying cost of inventory is as follows:
Carrying cost of inventory = ((inventory capital costs + inventory risk costs + inventory storage costs + inventory service costs) / total inventory value) x 100%
It’s important to distinguish these overheads from total manufacturing overheads, which include all additional costs related to producing goods.
6. Backorder rate
The backorder rate is a KPI that shows the percentage of orders received within a certain period that couldn’t be filled immediately. You calculate it by dividing the number of unfulfilled orders by the total number of orders received.
Backorder rate = total orders on backorder / total incoming orders
A high backorder rate often signals weaknesses in supply chain management or planning. Typically, it inversely matches with how accurate your demand forecasting is.
7. Sell-through rate
The sell-through rate KPI shows the percentage of your inventory that’s been sold compared to what you had available to sell for a specific product.
It’s a handy measure for assessing how well items are selling and can help you decide whether to adjust how much you’re producing or restocking.
To calculate this KPI, divide the number of units sold by the total units that were available for sale:
Sell-through rate = number of units sold / number of units available for sale
(For manufacturers selling products they’ve made in the same timeframe, calculate the sell-through rate by dividing the units sold by the total of the initial finished goods inventory plus the goods manufactured during that period.)
8. Demand forecast accuracy
Demand forecasting is essential for balancing stock availability and avoiding excess. It’s particularly critical for make-to-stock (MTS) manufacturers who base their inventory and production plans on demand predictions.
This KPI evaluates the accuracy of past demand forecasts by comparing them with actual sales, orders, and production numbers. It’s expressed as a percentage, where a lower figure means a more precise forecast. Though there are multiple ways to calculate this KPI, but a basic formula involves:
Demand forecast accuracy = (1 – ((actual demand – forecasted demand) / forecasted demand)) x 100%
9. Perfect order performance, on-time-in-full
The perfect order performance (POP), also known as the perfect order index or rate, is a key measure of order fulfillment efficiency. It shows the proportion of orders completed flawlessly, without any problems.
To calculate POP, subtract the sum of orders with any issues (late, incomplete, damaged, or inaccurately processed) from the total number of orders, then divide by the total number of orders:
Perfect order performance = (number of total orders – (number of orders not delivered on time + number of orders not delivered in full + number of orders delivered with damage or defects + number of orders inaccurately processed)) / number of total orders.
POP is similar to the on-time in-full (OTIF) KPI, which focuses on whether orders are delivered completely and on time. Unlike OTIF, POP also considers damages, defects, and processing mistakes.
On-time in-full = Number of orders delivered on time and in full / number of total orders.
Manufacturers aim for a POP or OTIF rate close to 90% to indicate high fulfilment efficiency. This metric can apply to your deliveries or to evaluate supplier performance, known then as supplier POP or OTIF.
Summary
To sum up, inventory management KPIs are critical metrics that focus on how a company manages its stock, including how much inventory is held, the costs involved, and how it moves.
Tracking these KPIs helps small businesses establish clear targets and get a better understanding of their operational status.
Key inventory KPIs are vital for improving stock valuation, gaining more control over inventory, reducing waste, and cutting down on unnecessary costs.
These KPIs are usually brought together in performance dashboards, which could be formatted as spreadsheets, included in specialized performance management software, or part of the MRP, inventory or warehouse management software used by the company.
Aiming to monitor about five to ten KPIs strikes a good balance, ensuring dashboards remain straightforward and free from excessive complexity.
Mike Lurye is the Director of Business Development at MRPeasy, a manufacturing resource planning software for small businesses.
Inventory stock image by Andrey_Popov/Shutterstock
