As a leading technology provider for some of the largest retail brands globally, we have witnessed how inventory can be the Achilles Heel for businesses across multiple industries. From millions of dollars drained in lost sales owing to inaccurate demand planning to inefficient promotions degrading the profitability, and high holding costs chipping the bottom lines as a double-edged sword – inefficient inventory planning comes with multiple drawbacks.
Among multiple other causes, the lack of proper tracking and optimizing as per the tracking metrics is one of the most challenging aspects of inventory planning. How to track inventory, what are critical inventory KPIs, what do they mean, and how to optimize inventory as per these metrics?
Below, we explore all these answers and discuss the top ten inventory KPIs every retailer must track.
1. Inventory Turnover Ratio
The inventory turnover ratio is obtained by dividing the total cost of goods sold by the average inventory. The inventory turnover ratio indicates how often inventory is sold and replaced and shows the overall business performance. A high inventory turnover ratio or stock turnover ratio indicates that the inventory is efficient.
Tracking the inventory turnover ratio helps retailers understand what they can sell, and how efficient sales are for the stock. Based on this ratio, they can plan the order frequency and stock replenishment.
2. Average Inventory
Average inventory is another important inventory KPI that is used to determine the inventory turnover ratio and indicates the amount of inventory available at a time. Average inventory is calculated periodically based on the unique business requirements.
Average inventory formula:
Average Inventory = (Beginning inventory – Ending inventory) / 2
Ending inventory is yet another metric that is used to calculate average inventory, and is depends on all the purchases done around the year.
Ending Inventory = Beginning Inventory + Purchases – COGS
3. Stockouts
Stockouts are a direct indicator of inventory health and show how often customer demand can’t be met owing to the lack of the right products. Apart from degrading customer experience, stockouts can cause direct harm to the revenue as 30% of customers switch stores after a single stockout event. Further, stockouts are directly responsible for a 10% sales loss.
Another key metric related to stockouts is the stockout rate, which is the percentage of products not available when they are required for sale. Stock rate is calculated by dividing the out-of-stock items by the total items available in the inventory.
4. Sell-Through Rate
The sell-through rate or sell-through ratio refers to the percentage of stock that is sold. It is one of those inventory KPIs that requires periodic measurement and tracking and a high sell-through ratio indicates efficient inventory and good sales.
Sell-Through Ratio = Amount to Sold Items / Amount of Received Items
It is also called liquidity ratio as it indicates the amount of inventory that has been sold. As stated above, a higher sell-through ratio is good, however, figures close to 100% might also indicate that retailers are running out of inventory. Hence, it is also one of the most critical inventory KPIs that every retailer should closely monitor.
As a standard practice, the sell-through rates are calculated on a monthly basis and are used to decide the replenishment schedule.
5. Holding Costs
Holding costs, also known as stock holding costs or inventory holding costs, can directly impact a retail business’s revenue and sustainability. They refer to the cost of storing unsold inventory that has been stored for specific periods or has become obsolete.
The duration of holding, nature of items in the inventory, shelf life of the items, depreciation, opportunity costs, and reason/intent behind storing the inventory are the determining factors of the overall cost a retailer must bear towards inventory holding.
Inventory Holding Cost = (Total Inventory Costs / Total Inventory Value) ×100
Having high inventory holding costs directly indicates poor inventory and business health and indicates situations like reduced profit margins, cash flow constraints, increased risk of obsolescence, operational inefficiencies, missed opportunities, higher storage & maintenance costs, etc.
6. Days Sales of Inventory (DSI)
DSI indicates how long it will take a retailer to sell the entire inventory during a specific period. It is yet another must-track inventory KPI for retailers that helps them understand and assess their sales performance and inventory management efficiency.
In simpler words, DSI means how many days the retailer takes to convert the entire inventory into sales, and it is calculated using the following formula:
DSI = (Average Inventory / Cost of Goods Sold COGS) × 365
Days sales of inventory directly indicate inventory management efficiency and a low DSI indicates efficient turnover and effective sales strategies, while a high DSI may suggest overstocking or weak sales. DSI also offers insight into cash flow, sales performance, etc.
Ideally, DSI should lie between 30 to 60 days and values above 60 days might indicate declining customer demand, or poor demand anticipation.
7. Demand Forecast Accuracy
How well the demand predictions match the actual recorded sales and how well the inventory sells as per the planned projections is another critical inventory KPI that every retailer should track. Demand forecasting accuracy is directly proportional to sales, revenue, customer satisfaction, and inventory efficiency, and paves the way for strategic business growth.
The demand forecast accuracy is calculated by many methods, such as Mean Absolute Percentage Error (MAPE), Mean Absolute Deviation (MAD), and Root Mean Square Error (RMSE).
DFA = (1− (|Actual Demand−Forecasted Demand∣ / Actual Demand)) × 100
A high demand forecast accuracy indicates optimal inventory, efficient replenishment, supply chain efficiency, and informed decision-making. Having a consistent high-demand forecast accuracy also reduces inventory costs by 10 to 20%.
8. Inventory Accuracy
It is yet another inventory KPI that every retailer must track and measure consistently. Inventory accuracy indicates how accurate the recorded inventory is and how well it aligns with the physical inventory in the warehouse.
Inventory Accuracy = (Actual Inventory / Recorded Inventory) × 100
High inventory accuracy indicates better operational efficiency and inventory replenishment planning. Maintaining high inventory accuracy helps reduce costs, and improve business planning, and robust decision-making.
9. Service Level
When it comes to inventory KPIs, it is very easy to overlook customer-related KPIs that can hinder the understanding of customer expectations and experience. To ensure granular accuracy and an in-depth understanding of demand patterns, it is important to measure and track customer-related KPIs, such as service level.
Service level means the percentage of customers that didn’t experience any stockout during an inventory replenishment cycle. So, it is a direct indicator of a retailer’s ability to fulfill customer demand in the most optimal manner.
A high service level means the retailers are able to deliver across customer expectations and the number of customers leaving without making a purchase owing to the lack of stock or absence of the right stock is low. Service level is one of those metrics that can significantly alter the sales value, revenue, and customer satisfaction with a slight increase.
10. Gross Margin by Product
As the name suggests, the gross margin by product refers to the profit percentage earned for a single product sold. This metric calculates the profit generated by the sale of each product against its cost and offers granular visibility over the efficiency of inventory at the product level.
Hence, it is a direct indicator of overall profitability and helps retailers make better purchasing decisions and plan optimal inventory.
Gross Margin = ((Sales Revenue − COGS) / Sales Revenue) × 100
Understanding gross margins by product allows the retailers to identify the highest-performing products, and sales performance of different items and make informed decisions for product assortment, pricing strategy, inventory replenishment, and more.
While measuring and tracking inventory KPIs is one of the most reliable and data-driven approaches to inventory optimization and replenishment planning, it is crucial to do so consistently and periodically for a uniform and reliable strategy. The next step in the process of building a data-driven and demand or profit-centric inventory is to leverage the insights at scale and take decisions at a product-location level for different stores, categories, etc.
