Welcome to Chapter 9 of our inventory management guide. In this chapter, we will cover inventory management KPIs and metrics that you will use to measure the effectiveness of your operations.
It takes time to determine which KPIs and metrics to measure and spot the difference between vanity and actionable metrics.
So, you’ll find that how you measure your performance will change the longer you work in inventory management and as your operations grow and evolve.
Too much? Head back to the inventory guide homepage. Finally, we’ll cover many acronyms in this chapter; check this post if you feel you’re getting lost.
What’s the Difference between a KPI and a Metric?
KPI stands for ‘Key Performance Indicator,’ and they are used to track progress toward specific goals, while metrics are general data points used for performance measurement.
With a KPI, you would have set a goal based on past performance. For example, a goal to replenish inventory at a certain daily rate.
Metrics are not based on goals. They just show you how well you’re operating.
Why Measure KPIs and Metrics?
KPIs and metrics are vital to gauging efficiency in inventory management. Their primary purpose is to:
- Help maintain service levels—keeping a watchful eye on KPIs and metrics helps keep inventory balanced so you don’t lose grip on incoming and outgoing stock.
- Pinpoint when certain actions are needed (some of which can be automated).
- Provide data on performance to help with decision-making and reporting.
On a deeper level, inventory management KPIs and metrics can show you when a major issue must be addressed. At times, you won’t spot these without the stats.
There may be an issue or room for improvement if a particular metric is declining or inconsistent.
Improving and maintaining performance metrics is a top priority for inventory management professionals. 75% of supply chain management have reported wanting to improve inventory management practices.
Often, inventory management mistakes are caused by simple things. Supposedly, human error causes up to 46% of warehouse errors.
You’ll also be able to spot trends about certain inventory that must be addressed.
Worryingly, as much as 43% of companies do not actively monitor their inventory. This can lead to all kinds of issues, as discussed in Chapter 7 on inventory tracking.
Top Inventory Management KPIs and Metrics
Before we dig into this list, it is important to note that you will uncover more KPIs as you work on your company’s operations. Not all KPIs will be ideal for your business, workload, and warehouse, and you may come across new ones and drop old ones that aren’t helping your operations.
This is because not all businesses are the same. However, the following are the ones you’ll want to watch. To learn more about KPIs beyond inventory management, check out this blog post.
Again, you will need software to measure KPIs and metrics.
(Note: Sellercloud’s reporting features help you keep up with your inventory based on product, warehouse, value, and aging. It features custom and pre-made reports and goes beyond inventory management.)
Without further ado, here are some of the most vital KPIs and metrics for inventory management.
What Is the Reorder Point (ROP)?
The reorder point KPI is the inventory level at which a new order must be placed to ensure there is enough inventory to meet demand until new orders arrive.
It can’t be calculated without historical data, like many of the KPIs in this chapter. Reorder can sometimes be spelled ‘ReOrder.’
(We mentioned reorder points before briefly in Chapter 4).
How Is Reorder Point (ROP) Useful for Inventory Management?
The reorder point is extremely helpful for those working in inventory management. It helps keep your inventory in balance by streamlining the flow of inventory into the warehouse.
Having reorder points defined allows you to reorder inventory only when a certain threshold is met.
You can avoid realizing too late that stock levels are low and miss the right moment to order and risk running out of inventory—or the opposite, end up with too much inventory that you can’t store or sell
Reorder points are about ordering what you need and not falling into dated practices of only ordering inventory at certain times in the week or month.
Reorder points can also be automated so new inventory is ordered as soon as the predefined reorder point is reached, sending a notification to warehouse professionals that they need to reorder.
How to Calculate Reorder Point (ROP)?
To calculate your reorder point, you need to know your approximate daily demand and lead time in days (we’ll explain lead time in a moment) and how much safety stock you have.
Here’s how to calculate your reorder point.
Reorder Point = (daily demand x lead time in days) + safety stock.
Take your daily demand, multiply it by your lead time in days, and then add your safety stock.
Here’s an example of what it could look like. Let’s say you sell 141 products in a day, and each order takes 3 days to deliver, and you hold 25 products as safety stock.
You would multiply the 141 products per day by the 3 days it takes to deliver and get 423, then add the 25 you hold as safety stock to get a total of 448.
(Note: You can set reorder points with Sellercloud—a feature many competitors lack.)
What Is the Minimum Order Quantity (MOQ)?
Minimum order quantity is a KPI for the smallest quantity of inventory that can be ordered from a supplier according to your company’s cost considerations or based on your supplier’s requirements.
How Is Minimum Order Quantity (MOQ) Useful for Inventory Management?
Minimum order quantity is very useful for several reasons, most of which are related to lowering the costs of procuring inventory from suppliers.
Firstly, ordering larger quantities typically results in lower unit costs.
For suppliers, it’s better to send large shipments than many smaller shipments as they have a higher gross value per shipment, which means they spend less on shipping per product, which is better for their margins.
Furthermore, you will order less frequently from your suppliers, saving you and your supplier time and money, which is also good for your business’s relationship with your suppliers.
Lastly, some companies use MOQ to take advantage of quantity discounts suppliers offer when ordering, which is important for your company’s bottom line.
How to Calculate Minimum Order Quantity (MOQ)?
To calculate the minimum order quantity (MOQ), you typically need to consider two main cost components—ordering costs and carrying costs.
These costs vary from one business to another, so how you calculate minimum order quantity may differ from other companies (not all KPIs and metrics are an exact science).
Furthermore, a higher MOQ usually means lower costs, while a lower MOQ usually means higher costs.
One way to figure out your minimum order quantity is through another metric called ‘Economic Order Quantity (EOQ).’ Here’s how you calculate EOQ.
Economic Order Quantity = √((2 * annual demand * ordering cost per order) / Holding cost per unit per year).
The above formula helps businesses determine the optimal order quantity that minimizes the total cost of ordering and holding inventory.
Of course, this formula will not be as useful in circumstances where the supplier dictates the minimum order quantity.
What Is the Maximum Order Quantity (MAX)?
Maximum Order Quantity is a KPI for the largest amount of inventory that can be ordered from a supplier (the opposite of MOQ), and it is often used to limit the amount of inventory held to reduce carrying costs.
Think of maximum and minimum order quantity as the limits of what you can order. They keep your inventory level and balanced.
How Is Maximum Order Quantity (MAX) Useful for Inventory Management?
You don’t want to order more stock than you can keep in your inventory, or you’ll have excess inventory that needs to be dealt with (perhaps sold onwards at a loss).
If you’re in desperate need of stock and demand is estimated to be high, you’ll want to check your maximum order quantity so you don’t overdo it.
How to Calculate Maximum Order Quantity (MAX)?
There is no special formula to calculate the maximum order quantity. It is based on your storage constraints, specifically the space you have reserved for a specific product.
Available space = total space – occupied space.
You can, however, calculate your maximum inventory levels. To do this, you’ll need to know your reorder point, reorder quantity, minimum consumption, and minimum lead time.
Maximum inventory levels = reorder point + reorder quantity – (minimum consumption x minimum lead time).
What Is Lead Time?
Lead time is a metric used to calculate the time it takes for inventory to be delivered after an order is placed. It includes all the inventory management tasks and fulfillment tasks.
Though lead time is more of a fulfillment metric than an inventory management metric, it is used to inform other KPIs and metrics in inventory management, such as reorder point and maximum inventory levels, both mentioned above.
How Is Lead Time Useful for Inventory Management?
Lead time is most useful to inventory management to calculate other KPIs—it helps inventory managers figure out their inventory turnover (the rate at which inventory arrives and exits the warehouse).
Lead time can also be used to figure out how time in the warehouse impacts how long it takes for a delivery to reach the customer.
You may need to change your inventory management practices to speed up lead time if it is too slow.
How to Calculate Lead Time?
Lead time is another metric that doesn’t have a defined, ‘correct’ formula. That said, lead time is typically measured in days, and you can do it by subtracting the order request date from the order delivery date.
Lead time = order delivery date – order request date.
Similar metrics are used to track how quickly orders travel through the warehouse, from when the order is made to when it leaves the warehouse, such as Warehouse Turnaround Time, which specifically measures how long it takes for a product to move through the warehouse.
What Is a Service Level?
Service level is a KPI that indicates the percentage of orders that can be fulfilled immediately from available inventory without experiencing a stockout (when you run out of stock).
How Is Service Level Useful for Inventory Management?
Service level is useful because it helps inventory management professionals calculate how much inventory they need to order based on demand.
It helps ensure there’s enough inventory to mean orders without ordering too much inventory.
Service level can also be used to measure the performance of your inventory policies. If the service level is very low, it may be worth rethinking how your warehouse handles the workload.
How to Calculate Service Level?
Service level is calculated as a percentage. To calculate the service level, you need to know the number of orders filled correctly and the total number of orders.
You divide the number of orders filled correctly by the total number of orders and multiply that number by 100 to get the service level percentage.
Service Level (%) = (number of orders filled correctly / total number of orders) x 100.
For example, let’s say you had completed 692 orders correctly out of a total of 735 orders in a given period. You would then divide the 692 completed orders by the 735 total orders, which gives you 0.94.
Now multiply 0.94 by 100, and you will get a service level of 94%.
There are three primary service levels:
- 95% and above—high service level.
- Between 85% and 95%—medium service level.
- Below 85%—low service level.
What Is Cycle Count?
Cycle counting is a metric used to periodically ensure that records are correct in your system by doing a physical count.
We mentioned this before when discussing the difference between periodic and perpetual inventory management systems in Chapter 4.
Cycle counting is a periodic technique but should still be used when using a perpetual system just in case your inventory management system records are incorrect.
How Is Cycle Count Useful for Inventory Management?
Cycle count is useful because if there is a discrepancy between what is recorded and what you physically store in your inventory, you can investigate it.
These discrepancies can be caused by all kinds of errors (don’t believe that because you have software in place, problems will disappear).
While you might not immediately know why there is a discrepancy, at least you know there is one. Remember, almost half of all warehouse errors result from human error.
(There can even be situations where there is more physical inventory than what is recorded.)
How to Calculate Cycle Count?
Calculating a cycle count is pretty simple. After counting your inventory, you subtract the number from the number recorded.
Cycle count = physical inventory – recorded inventory.
It is advised that cycle counts are done in subsets of your inventory instead of counting everything in your warehouse, which would be a monumental task and get in the way of other operations.
You can schedule different parts of your inventory to have a cycle count and determine the frequency of counts.
You must also decide if certain inventory needs to be counted more often than others. For example, if certain products move in and out of the warehouse faster than others, there may be an increased chance of errors.
Cycle count frequency is another metric that helps you determine how often to do a cycle count. The frequency of cycle counts depends on things like historical accuracy, business needs, and how critical the items are.
Here’s how you’d work out cycle count frequency:
Cycle count frequency = (total number of items to be counted) / (number of items to count per cycle).
And here’s a simple-to-understand example.
If you had 1,000 products in your inventory and wanted to count 100 items per week, the cycle count frequency would be 10 weeks, as you’d divide 1,000 by 100.
This means you would cycle through your entire inventory every 10 weeks, counting 100 items each week.
Key Points From Chapter 9
Remember these key points from Chapter 9 of our inventory management guide.
- The difference between KPIs and metrics is that KPIs measure your work towards a set goal.
- Not all KPIs and metrics you will come across will be useful to your company. It depends on your business and operations.
- The KPIs and metrics you rely on will change over time as you learn what is most useful and your business matures.
- Some of the most important inventory management KPIs and metrics you should monitor are reorder point, minimum and maximum order quantity, lead time, service level, and cycle count.
- Sellercloud’s reporting features can help keep inventory management professionals on top of all their inventory management tasks.
You’ve just finished reading Chapter 9 of the inventory management guide on KPIs and metrics. Chapter 10 will focus on handling returned inventory.