How to Measure Inventory Performance

To find the answers, your business should monitor relevant key performance indicators (KPIs) aligned with your operations. The first place to focus is inventory. Inventory ensures businesses can deliver what customers want, when they want it. But how do you strike the fine balance between having enough and having too much?

Holding inventory is costly. There are opportunity costs, since that capital can't then be invested elsewhere. Then there are the costs for warehousing, staff, electricity, and other storage expenses. Finally, inventory is a risky investment. If demand shifts before the entire inventory is sold, the remaining items in stock may be significantly reduced in value and must be sold at a discount. Or worse, not sold at all.

The right KPIs, though, will help manage this risk. Let’s take a look at the first three today.

1. Inventory turns or inventory days on hand

This KPI measures how well an organization moves inventory. Simply put, it shows how often the organization has sold the full value of its inventory over the year. A related metric is inventory days on hand, which shows how many days it would take to deplete the organization's average inventory.

Obviously, the faster an organization moves inventory, the lower its total inventory carrying costs will be, since it can sell it at full price rather than discount it when it becomes obsolete. Furthermore, keeping inventory in the warehouse for a shorter period reduces costs for electricity, cooling, and inventory staff per item.

This KPI is likely to vary considerably across industries. If you’re trying to set a target for inventory turns, benchmark against comparable companies in the same industry or against your company's past performance.

2. Backorder percentage

Also known as “fill rate,” this is the percentage of orders that can't be filled at the time they are placed. Think of it as the percentage of orders that can be filled at the time they are placed.

The importance of this KPI depends on the time sensitivity of your industry. In other words, how quickly and easily can your customers find an alternative supplier? For a supermarket, even a small percentage of backorders on staples such as milk or bread can lead to customer loss, since these customers usually need the item immediately and have other options to get it.

This can also apply to suppliers of critical components to business customers. No matter what they’re buying, no customer likes to wait, and an organization should carefully consider the consequences of keeping customers waiting.

3. Inventory service level

The inventory service level denotes the ability to service incoming orders from stock. The relationship between the amount of inventory and the service level is not linear.  Even small increases in an already high service level can require doubling the stock level, for example.

Mathematically speaking, an inventory service level of 100 percent requires an infinite amount of stock. Organizations must therefore carefully consider the costs of lost customer orders that cannot be fulfilled from stock when determining their inventory service level.

When assessing inventory service level performance, it's important to consider not only whether the target service level was met but also whether it was exceeded. If an organization's customers are satisfied with a 95% inventory service level and the service level is not a competitive parameter, expending resources to achieve 99% might not be the right decision.

One solution to cover all analytics and reporting needs

From our review of key inventory performance measures, it is clear that to drive improvement in this area, an organization must not only have access to inventory data in a clear, consistent format but also a robust understanding of what its customers want.

A business intelligence system can present inventory data in a way that supports decision-making, but only the organization’s employees can use this data to make the difficult trade-offs between inventory costs and the ability to serve customer needs immediately.

And that's why TARGIT Decision Suite is designed to give your entire organization easy access to information and empower people to make better, faster, data-driven decisions.