How to: Measure Your Inventory Levels

Inventory performance metrics are essential to the running of your business. They help you measure how well you and your team are doing at managing your inventory. Here are three major points that you definitely need to know to equalise your inventory levels in the short and long term.

Inventory Turnover Ratio

The inventory turnover ratio tells you how well you are doing at selling your inventory and keeping it flowing at a healthy pace through your warehouse. Having a low inventory turnover ratio means you have high carrying costs and you may be overstocked on slow-moving items. Having an extremely high ratio may mean you’re not ordering enough and you’re struggling to keep enough on hand, potentially resulting in shortages.

To calculate your company’s annual inventory turnover ratio:

Divide the annual cost of goods sold by the average annual cost of inventory on hand.

Economic Order Quantity

The Economic Order Quantity (EOQ) is the number of items you should reorder each time you place a new order to maximize efficiency while keeping carrying costs and shipping costs to a minimum. Here is how to calculate the EOQ for each part and product in your inventory:

  1. Multiply annual fixed costs by the annual demand in units.
  2. Multiply that total by 2.
  3. Divide that total by the annual carrying cost per unit.
  4. Take the square root of that result.

Reorder Point

To calculate the reorder point for each product, you need to know four terms:

  • Lead Time: The number of days between a purchase order’s issue date to the product’s arrival at your warehouse.
  • Safety Stock: The number of days’ worth of a product you keep on hand to prevent emergency shortages.
  • Basic Stock: The number of days’ worth of a product you keep on hand as a part of your daily operations.
  • Unit Sales Per Day: The average quantity of a product that you sell on a daily basis.

Once you have those figures, plug them into this two-step equation to discover any product’s reorder point:

  1. Add the lead time, safety stock, and basic stock together.
  2. Multiply that total by the unit sales per day.

There you go. The inventory turnover ratio, EOQ, and reorder point will help you measure how well you’re doing at managing your inventory. These will generate concrete numbers you can track over time to see whether or not you’re progressing and how you can improve.

This post originally comes from Robert Lockard in the Fishbowl USA team

Published by

Alan-Dean Simonds

Alan-Dean Simonds works at Fishbowl Australia and makes sure that everyone is knowledgeable about the popular inventory management software for Reckon (formerly QuickBooks) users. Dean enjoys playing StarCraft II, creating 3D animations and watching movies.

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