MARCH/APRIL 2012 Article

Inventory Management–You Manage What
You Measure

Learn more about how tracking these key performance indicators for inventory management can help you drive performance excellence . . .

Effective inventory management techniques allow you to streamline your inventory processing, ensure that your inventory is moving briskly, and make sure your profit margin continues to grow. An old axiom states that what isn't measured can't be improved. From an inventory perspective, the metrics that measure success can be very complicated to calculate without seamless integration of information into your business management system.

Fast and accurate calculation of key performance indicators allows you to stay on top of inventory processing so you can make needed adjustments to standard operating procedures to reach optimal inventory. Here's the bottom line:

OPTIMAL INVENTORY = Lowest Inventory Cost + Highest Sales

Explore the following Inventory KPI metrics to see how Sage ERP Accpac (becoming Sage 300 ERP) automated Inventory Management can lower your costs:

Inventory Turns = cost of sales / average inventory value

Inventory turnover ratio measures the velocity of conversion of stock into sales. The inventory turnover ratio is also an index of profitability, where a high ratio signifies more profit while a low ratio signifies low profit. Usually a high inventory turnover/stock velocity indicates efficient management of inventory because the more frequently the stock is sold, the less money is required to finance your inventory. A low inventory turnover ratio indicates an inefficient management of inventory. A low inventory turnover implies over investment in inventories, dull business, poor quality of goods, stock accumulation, accumulation of obsolete and slow moving goods, and low profits as compared to total investment. If you can increase the speed and efficiency of handling your merchandise, your cash flow and profit will sky rocket! This is due to receiving a higher return on your investment and lower associated inventory carrying costs.

Cost of Goods Sold (CoG's) = Beginning Inventory + Inventory Purchases – End Inventory

The Cost of Goods Sold typically is the largest single expense for most companies, so this figure is extremely important. This figure alone is not really of much value, as it needs to be compared to other financial figures, such as Net Sales or Inventories. An especially good sign for a company is if the Net Sales is increasing over time and the Cost of Goods Sold is not increasing as much, staying the same, or the best case–going down! This could mean that while its sales income is increasing, it is able to manage its costs associated with selling those goods or services.

Gross Margin (GM%) = sales – cost of sales / sales

Gross margin is what is left over after costs associated directly with the sale of a product or service–such as materials and direct labor–are paid. A high gross profit margin ratio indicates that a business can make a reasonable profit on sales, as long as overheads do not increase. Investors pay attention to the gross profit margin ratio because it tells them how efficient your business is compared to competitors. It is sensible to track gross profit margin ratios over a number of years to see if company earnings are consistent, growing, or declining. Knowing your gross profit margin ratio is important because it tells you whether your business is pricing goods and services effectively. A low margin compared to your competitors would suggest you are under pricing, while a high margin might indicate overpricing. When a firm is generating adequate sales but gross margins are low, it signals an issue in one or both of these areas.

Carrying Costs and Inventory Levels

Carrying Cost = Inventory Carrying Rate X Average Inventory Value

Carrying cost is the cost a business incurs, over a certain period of time, to hold and maintain inventory levels. Businesses use this figure to help them determine how much profit can be made on current inventory. It also helps them find out if there is a need to produce more or less in order to keep up with expenses or maintain the same income stream. Carrying cost of inventory is often described as a percentage of the inventory value. This percentage could include taxes, employee costs, depreciation, insurance, cost to keep items in storage, opportunity cost, cost of insuring and replacing items, and cost of capital that helps produce income for a business.

Perfect Order

Perfect Order = Order Entry Accuracy * Warehouse Pick Accuracy * Delivered on Time * Shipped Without Damage * Invoiced Correctly

"Better, faster, and cheaper" just isn't good enough anymore; customers today are demanding perfect orders, shipped and delivered on time to the minute, at a cost that barely leaves any margin for error–or profit. Perfect Order is more than simply measuring your percentage of Orders Shipped on time. What really matters in today's consumer driven economy is: "Did customers get what they want, when they wanted it, how they wanted it?" By definition, a Perfect Order is achieved when a customer can contact your organization, place an order for a product in a timely manner, have the product available when they want it, at the price they are willing to pay, have it delivered when they want it without damage, and be able to pay the invoice without any problems. These actions transcend every aspect of your organization. The customer service, production, inventory management, distribution, and finance functions all must be working together to allow your organization to reach Perfect Order status each and every time. Perfect Order measurement truly captures what is happening in your business and how satisfied your customers are with your order delivery performance, which is critical for continuous improvement in customer service.

Without an inventory management system in place, you may find it difficult to obtain these key performance indicators. A system like Sage ERP Accpac (becoming Sage 300 ERP) allows you to track detailed inventory data and provides key reports and business intelligence for better inventory management.


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