Inventory Control Methods and KPIs

Inventory Control Methods and KPIs to Save your Business

By definition, inventory control, which is also commonly known as stock control, is the process of maximizing the use of an organization’s inventory.

Inventory control is how an organization can maximize profits with minimum inventory investment without affecting customer demands in an economical way. It involves looking at one’s stock and maintaining accurate stock levels.

Inventory management is no smooth sailing.

By having inventory control, you will be able to process orders quickly, achieve good results in terms of delivery and ultimately provide better customer service.

Let’s take a look at some inventory control methods to manage your business proficiently. These will help you to maintain balance in stock levels, organize the warehouse efficiently, thus creating an inventory management setup that proves unbeatable.

ABC Analysis

In A-B-C analysis, inventory is categorized into three sets to determine the degree of control for each.

A items – these are products whose annual consumption value is the highest.

B items – these are items with moderate consumption value

C items – These are the least valuable goods, with the lowest consumption value.

Avoiding stock-outs in A items is the primary concern. These items require tight inventory control, more secure storage areas and accurate demand forecasting. They will have greater number of reorders, in contrast to other items.

B items require close monitoring as they might have the potential to progress towards class A or in unfavorable circumstances, towards class C.

With C items, the confusion is whether they are needed or not. Since their annual consumption is the lowest of all, businesses prefer keeping low or no stock of such items.

The ABC analysis can also be useful in tweaking the placement of products in the warehouse, where items A can be kept closer to the picking, packing and shipping areas while C items can be kept at the back.

Minimum Safety Stock

Safety stock is the ‘buffer’ inventory that is ordered and kept in excess of demand. Should the demand for products suddenly rise at any occasion, safety stocks save the day by preventing ‘out of stock’ situations.

For instance, if an order is placed when the stock reaches 10000 units instead of 8000 units, then the extra 2000 units comprise the safety stock. The seller expects to have 2000 units till the new order arrives.

For safety stock calculation, you need to first know your maximum daily usage, maximum lead time, average daily usage and average lead time.

Safety stock=  (maximum daily usage * maximum lead time) – (average daily usage * average lead time)

Replenishment/ Reorder Point

When you have new products that are selling fast, then you need to quickly replenish that stock. But if you reorder too quickly, you will need warehouse space to store it, and if you are too late then you risk stock-outs or utilizing safety stock.

The reorder point tells you exactly at which point you need to reorder stock. Thus, it is imperative to know the lead time between ordering stock and then goods being delivered. The reorder point is calculated as lead time multiplied by daily usage.  If safety stocks are kept, then those are added to the equation.

Reorder Point= (lead time * average daily sales volume) + safety stock

For example, if the daily usage of stock is 50 units and it takes 10 days for the supplier to deliver the goods, then an order must be placed when the stock level reaches 500 units.

FIFO and LIFO

The first-in-first-out method or FIFO, is based on the principle that oldest items or those procured first will be sold first. This method is especially beneficial for perishable items such as food, medicines, cosmetics, etc. FIFO could also be used for non-perishable items. If a product is not selling, it may eventually expire or become outdated.

Another inventory control method that is used is LIFO. LIFO, the full form of which is ‘Last-in-First-out’, is the exact opposite of FIFO. In LIFO, the latest inventory or that bought most recently is sold first. An example of a product that can be sold by LIFO could be electronic since businesses would always prefer to sell the latest items or models they have purchased.

Just-In-Time

The JIT method is a popular inventory control technique in a manufacturing environment that provides ‘just in time’ fulfillment. In this method, stock is reordered only when there is an immediate requirement.

The main purpose of JIT is to reduce dependence on safety stocks and eliminate wastes. It assists the business in better forecasting of their inventory requirements ‘just in time’.

Economic Order Quantity

The economic order quantity(EOQ) is a means to figure out how much stock needs to be reordered for a particular product. At the same time, you also need to make sure that the inventory order and carrying costs are minimum.

EOQ is based on 3 variables:

  • Demand– The number of units sold over a given time period, usually a year.
  • Relevant ordering cost– Total ordering cost per purchase order.
  • Relevant carrying cost– Assuming the item remains in stock for the entire time and calculate the carrying cost per unit.

EOQ = √2 (Demand*Order cost)/ Carrying cost per unit

Cycle Counting and Auditing

You should conduct regular large-scale audits of your entire inventory. The inventory you think you should have must match the same number in the ledgers. In case of discrepancies, you can do spot-checking of incoming & outgoing orders and available inventory. This will enable quicker identification of errors and resolution before they turn into bigger mistakes.

Cycle counting is a faster alternative to full audits. Cycle count accounts for inventory when the warehouse is divided into smaller sections. With smaller sections, cycle counting is done more frequently and gives insight into the accuracy of the warehouse.

Inventory Budgetary System

Inventory budgeting involves the planning, execution and supervision of inventory operations. An annual inventory budget is prepared beforehand wherein factors like number of units to purchase ad safety stock are all decided. The inventory budget helps to control consumption levels and reduce waste.

Inventory Management System

You can manually update information on excel sheets or ledgers or you can utilize an inventory management system.

However, manual data entry is more susceptible to errors. An inventory management software minimizes manual work and ensures accuracy of information.

Inventory management system provides real-time data so you know the exact status of your inventory. It also tracks your goods each time an order is received, until it leaves the warehouse for shipping.

KPIs To Measure for Inventory Control

Receiving Efficiency

Receiving incoming stock properly is an important yet tricky task as each day/ week, inventory in different forms such as new stock, return items arrive in the warehouse.

Tracking such frequent and large amounts of inventory is essential to maintain accurate stock levels. This can be measured by keeping records of time taken to receive, count, and store new inventory each time.

Picking Accuracy

Warehouse organization is essential for smooth inventory and operations management. Order picking, a crucial activity in order fulfillment, is also a complex one.

Inefficient order picking leads to misdelivered packages, returned items and cost of reverse logistics.

To calculate picking accuracy, you can use the following formula:

Picking Accuracy= (total no. of orders- incorrect returns/ Total no.of orders) * 100

Inventory Turnover Ratio

Inventory turnover is the number of times a company has sold their inventory in a given period of time. Inventory turnover ratio explains the efficiency of an organization with regard to making sales from their inventory. The inventory turnover ratio is calculated by dividing the cost of goods sold by the average inventory in the same accounting period. An example could be- if the cost of goods sold is $100,000 and the average inventory is $10,000, when divided comes up to 10. The inventory turnover ratio can tell you the inventory turnover period. Assuming that the turnover period is 365 days, by dividing 365 with 10, it equals 36.5. This calculation means inventory turned over 10 times in the year and was on hand for around 36 days before selling out. The higher the inventory turnover ratio, the better it is.

Backorder Rate

Backorder rate is a warehouse management KPI that allows sellers to deeply understand the efficiency of their forecasting. A high backorder rate is an indication that orders are coming in for products that are out-of-stock. Backorders can increase due to unexpected rise in demand but a consistently high backorder rate is a sign of poor inventory control and planning.

Backorder rate can be calculated by the following formula:

Backorder Rate = Order Unfulfilled at Time of Purchase/ Total Orders

Return Rate

This KPI determines how often items have been returned. This metric gives an idea about the customer satisfaction level. The best way to use this KPI is to divide returns on the basis of reason.

For example, too many returns due to incorrect item delivery denotes inefficiency in the picking process.

This way understanding several reasons can give greater insight into customer buying behavior. Use this formula for each reason and determine return rate:

Rate of Return= No. of units returned/ No.of units sold

Order Lead Time

This is the average time takes for customers to receive their orders after being placed. A shorter lead time makes happier customers.

An optimum order lead time can also improve order cycle time which the length of time between customer orders.

Carrying Cost of Inventory

Carrying costs shows what is the cost of holding inventory in the warehouse over a certain timeframe.

It adds up all costs associated with storing inventory  including insurance, taxes, utilities, maintenance, storage rent, personnel and equipment.

Carrying costs allows for better forecasting and inventory planning in order to maintain cash flow and reduce waste.

Carrying costs can be calculated with the following formula:

Carrying cost of inventory= (average inventory value/ total carrying costs) * 100

Summing Up

The above mentioned inventory control methods are important to maintain accurate inventory levels in your warehouse at all times. The KPI’s help to measure the efficiency of your warehouse management processes.

Kriti Agarwal

Kriti Agarwal

Avid reader. Daydreamer. Perfect Saturday evening is a cup of coffee with a classic book. Mountains over beaches. Loves animals. Always craving for stories. Writer at Orderhive.

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