For busy manufacturers and wholesalers, inventory metrics are a fast and reliable way to gauge the performance of the business. Although there are higher-level metrics, like the current ratio or the debt-equity ratio, there’s particular value in checking in on inventory performance. Inventory stock is often one of the largest assets on a business’ balance sheet, so it’s crucial to take a financial view. Here are five inventory metrics to keep an eye on.
Cost of Goods Sold
Cost of goods sold, or COGS, is what it says on the tin; it’s the total variable cost of the inventory stock that is actually sold to customers. Inventory-heavy business already know that COGS is important from a tax perspective but it’s also a useful metric to take into account when comparing product lines and when deciding how to price your products profitably.
Within any growth-focussed business, increasing efficiency is likely to be a key consideration. One approach to measuring efficiency involves closely examining business processes to identify waste and delay – a crucial exercise from time to time. But for a quick read on how efficiently the business is operating, it’s hard to go past gross margin. The gross margin is calculated as your business’ total sales revenue less its cost of goods sold, divided by the total sales revenue.
Inventory on Hand
Half of the battle in inventory management amounts to knowing how much inventory your business has on hand at any given time. If you’re familiar with how much inventory stock your business should have on hand, a quick glance can tell you whether to set up an order or hold fire.
A common measure of inventory turnover involves dividing the cost of goods sold by ‘average inventory’. This requires you to work out the average total value of inventory stock in a given period for example, if you start the year with $200,000 of inventory and end with $300,000, your average inventory is $250,000, being ($200,000 + $300,000)/2.
The inventory turnover ratio essentially describes how many times a business cycles through entirely new inventory in a given period. It’s a useful diagnostic tool; if your inventory turns over too slowly, your business may be holding excess stock, whereas a very high turnover may suggest your business is holding too little inventory to safely satisfy demand. This metric is likely to look different in a lean business than in a business that carries safety stock.
Days of Supply
This is another useful metric to assess whether you’ve got the right amount of inventory on hand. Days of supply is calculated as inventory on hand divided by average daily usage. If you’re taking a lean approach to inventory, days of supply will usually be low. If not, consider whether your days of supply sufficiently insulates your business from the risk of a supply chain disruption.
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.