Inventory cost is tied up with excessive inventory that a business is holding over a period of time. The longer a business holds an inventory the cost attached to the inventory gets aggregated.
Nonetheless, maintaining an optimal level of inventory is one of the fundamental prerequisite for any business, and it should be done with a lot of precision. The complexity of Inventory management brings forth a number of costs that must be considered by online sellers for profitable selling.
It is important for businesses to start with a set of questions that helps them streamline and efficiently manage their inventory costs.
So, here are some questions that every business, dealing with online commerce, irrespective of being a seller, drop-shipper or manufacturer; should consider for calculating the real cost of inventory.
How much time my inventory stays in the warehouse?
How much money do I spend in procuring products/raw materials?
What is the average sale I make against my average purchases?
Which are the product I should stop investing in order to minimize the no of SKUs?
There are various touch points, if you are investing in low margin products then it’s likely that you won’t meet your expected revenue. On the other side, if your product is slow moving goods, you are spending way too much in maintaining your stock which brings strong variation to the overall cost.
In this blog, we will unfold various metrics which are also called inventory KPIs that help you monitor your business performance & maximize your profit margin.
Let’s take a look at each inventory costing factors and see what steps you can take to reduce these cost.
( A ) Reduce the Inventory holding cost
Inventory holding cost covers two important components
- Ordering Cost: Ordering cost depends on two major factors one is the cost of ordering too low or cost of ordering too high. Ordering excess quantity will result in carrying cost of inventory, whereas ordering less will result in the increase of replenishment of stock. The supplier’s shipping cost also bring strong variations on the cost per unit of order.
- Carrying Cost: How much are you spending on storing your inventory? Which include renting storage facilities, electricity, wages etc.
How to control these cost, calculate the correct Reorder point
If you know your re-order point you’ll know when’s the right time to plan orders for new shipments. That means you won’t be spending more on storing excess items or risk the shortage cost that makes you lose an order & customer.
Metric to calculate Reorder Point
You might have a question regarding the Safety Level Stock!
What is a Safety Level Stock?
SAFETY LEVEL STOCK: The number of days’ worth of inventory you keep in case of emergency.
Metric to calculate Safety Level Stock
“While Reordering point indicates the best time to refill your stock, Inventory turnaround help you to understand exactly how much quantities you should be purchasing at a given time so you don’t need to bear the unnecessary cost of holding the inventory.”
(B) Keep a check on your Inventory turnover ratio to improve sales-through rate
The speed at which a company can sell its inventory is a critical measure of ROI. Inventory Turnover is a measure of the number of times inventory is sold in a period of time.
Low-turnover implies – Weak Sales – Excess Inventory
High-turnover ratio implies – Strong Sales
Metrics for calculating Inventory Turnover Ratio
There are defined industry standard with which business compare their Inventory turnover ratios and take the necessary actions to improve it. However, a company who is selling a fast-moving consumer goods, such as perishable goods should have a considerably higher turnover ratio. Whereas the businesses who deals in high-end products like household appliances, automobiles etc will definitely have a low inventory turnover ratio.
So the question is, How to evaluate whether your Inventory Ratio is optimized?
By calculating your Sell-Through Rate
Sell-Through Rate is derived by comparing the amount of inventory a retailer receives from a manufacturer or supplier against what is actually sold to the customer (sales/stock on hand).
Sales-through rate Metric
Taking an example: If you bought 1000 unit of Product A from a supplier and in 30 days of time you have sold 400 units to the end customer.
Your Sales through rate will be = 400/1000 * 100 = 40%
( C ) Calculate your top performing SKUs and stop investing on low-margin/low
on demand products
An SKU profitability calculation is very critical as it is
- A leading indication of the margin performance for each SKU and SKU group
- It rightly indicate on which products you should have your focus on
- Help you identify areas which need operational improvement
- Increase visibility to operational performance against costed standards
Calculate the SKU Ratio
Calculate the Sales Ratio
The best performing SKU will be the one where the Sales ratio is higher than the SKU ratio.
Image Source: Practical Ecommerce
Comparing the SKU ratio to the sales ratio shows the best performing SKU range — where the sales ratio is higher than the SKU ratio by the largest amount.
Performing data driven analysis can be a tricky thing
With these metrics, you’re on the right track to forming a data-driven strategy that will enable you to take informed decision and implement best inventory cost control measures. However, data management is a very complicated process especially when you are selling on multiple platforms.
Orderhive is a SAAS based inventory management solution that extracts data from all selling channels and provide real-time analytics which enable you to optimize your inventory level and thereby reduce unnecessary cost attached inventory management.