Inventory analysis is defined as the techniques to determine the optimal inventory level needed for your business or warehouse. Proper inventory levels can be determined in a few different ways, which we will dissect here.
What is Inventory Analysis?
As we said, inventory analysis helps determine the proper level of inventory your business should carry, by SKU and location, to maintain a good inventory flow. It is highly valuable for business owners of both online and brick and mortar stores for inventory management. Other industries like grocery, clothing, and more should be fully utilizing inventory analysis in their business.
Inventory analysis helps you do many things, such as:
- Merchandise your products more accurately.
- Price your products competitively.
- Optimize your marketing strategy.
- Know when and how to order more stock.
- Optimize categories and product strategy.
- Get up-to-date on customer demand.
- Maintain an accurate cost of goods sold.
An inventory analysis will call out both wins and losses within your inventory strategy. You can find big gaps in slow-moving stock or find your best-sellers that could use some pricing and merchandising optimization. Either way, you will be able to trim the fat and build out some legitimately effective inventory management strategy.
8 Important Inventory Metrics to Track
GMROI is the gross margin return on investment. This number determines how profitable your inventory is. It shows how much cash comes of the inventory sold, minus its cost. Breaking even is great and can keep your warehouse functioning for a while. Still, inventory profitability is essential to continue to grow and function as a business.
The results of the GMROI are determined by dividing the gross margin (total revenue – the cost of goods sold)/total revenue) by avg. Inventory cost. This number can give you a good idea of how well your pricing strategy is. It can lead to negotiating better costs or setting more competitive pricing.
Inventory turnover is a key metric to measure that can show the health of your warehouse. The inventory turnover ratio is how many times you sell through and replace your inventory in any given period of time. In general, inventory turnover is measured annually for a year over year comparison, but you can also do it quarterly, but it won’t be accurate.
A good number of annual inventory turnover should be between 5 and 10. If you can go through your inventory of an item that many times, you have good flow and likely some profitability. A low inventory turnover would mean you have inventory sitting in your warehouse for far too long. This can be especially bad for warehouses holding items with expiration dates or those that will have new versions coming out, and they become outdated.
When you have a low inventory turnover, you should consider how much you stock of an item and what you price it at.
Fill rate is a simple formula that determines how many customer orders places were shipped in full. To find the fill rate, you would take the total customer orders shipped in full and divide it by the number of orders placed. You can use either that number or you can multiply it by 100 to get the percentage.
A warehouse should always strive to have a 100% fill rate. Backorders and out of stock inventory will cause your fill rate to go down. By managing your inventory properly, you can more likely reach a fill rate of 100%.
Average Inventory Level
The average inventory level is determined by taking the current inventory balance for a specific period, adding it to the prior time period inventory balance, and dividing by two. For example, if you wanted to determine year-over-year inventory levels, you could take today’s inventory level, add it to the same date from last year and divide by two.
Cost of Goods Sold
COGS are an important metric to measure as you need it to calculate both gross income and net income. Cost of goods sold includes all directly related costs to produce the goods sold by your business. This includes materials and labor as operational costs, but not distribution or sales costs. To calculate COGS, you do Beginning Inventory + Purchases During the Period – Ending Inventory = Cost of Goods Sold.
Sudden surges in customer demand can cause what is called a stock out. This is when stock is not available on its intended date or necessary date. The stockout rate is the percentage of this. It would be best if you had a few key pieces of data to figure out this percentage. You need lost sales, which is the total value of lost sales due to the product being out of stock, and total supply chain revenue. The formula to determine your stock out rate is Lost Sales ÷ (Revenue + Lost Sales) x 100%.
Inventory shrinkage is essentially inventory totals dwindling due to outside forces. Mostly theft, discounts, or damage make up the majority of inventory shrinkage. However, incorrect or miscounted outgoing inventory can also be a cause.
Shockingly, employee theft is actually the leading cause of inventory shrinkage, followed by shoplifting, administrative, fraud—seen here. Ramping up security measures like restricting access to the warehouse and requiring employee ID badges everywhere can help mitigate risk against employee theft. Assign initials or an employee name to each touchpoint of inventory to track where and why inventory would be off for a certain SKU.
Customer Service Levels
Measuring customer service levels is critical to your business’s success and gives you a direct insight into how your inventory practices are reflecting upon your customer base. Things like customer reviews, on-time deliveries, returns, exchanges, and other customer-specific metrics can tell you a lot about how well your shipping and receiving department is doing, as well as the integrity of your products.
By measuring the right metrics over the right periods of time, you can get a pretty clear view of your inventory practices and how they measure up to the competition. As you can see now, inventory analysis is not just measuring how much inventory is going out vs. in. It requires a detailed analysis of customers, demand, loss, profit, shipment times, etc.
The list goes on, and by tracking these metrics at the very least, you are on the right track towards proper inventory analysis for your warehouse. Using products like TopShelf, which we offer, you can even more easily track and define your internal metrics to drastically improve your warehouse operations and inventory.