Inventory Control Methods and KPIs

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. 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 look at some inventory control methods:

ABC Analysis

Inventory is divided into three sets in A-B-C analysis in order to ascertain the level of control for each.
Products with the highest yearly consumption value are classified as A goods.
Items with a moderate consumption value are classified as B items.
Items in category C have the lowest consumption value and are therefore the least valuable things.
The main thing to worry about is preventing stock-outs of A products. Accurate demand forecasting, strict inventory control, and more secure storage spaces are necessary for these commodities. Compared with other products, they will be reordered more frequently.
Items in class B need to be closely watched since they could move toward class A or, in the worst case scenario, 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

The “buffer” inventory that is ordered and maintained in excess of demand is known as safety stock. By averting “out of stock” situations, safety stocks come to the rescue whenever product demand spikes unexpectedly.
For example, if an order is placed when the stock reaches 10,000 units rather than 8,000, the safety stock is the additional 2000 units. Until the new order arrives, the seller anticipates having 2000 units available.
You must first determine your maximum daily usage, maximum lead time, average daily usage, and average lead time in order to calculate your safety stock.

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 well, you must restock your inventory right away. However, ordering again too soon will require warehouse space for storage, and ordering too late puts you at risk of running out of stock or having to use safety stock.
The precise moment at which stock needs to be reordered is indicated by the reorder point. Knowing the lead time between placing an order for stock and the delivery of the goods is therefore essential. Daily usage multiplied by lead time yields the reorder point. Safety stocks are included in the calculation if they are maintained.

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 amount of stock that needs to be reordered for a specific product can be determined using the economic order quantity, or EOQ. You must simultaneously ensure that carrying costs and inventory order are kept to a 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

KPIs To Measure for Inventory Control

Receiving Efficiency

Accurately receiving incoming stock is a crucial but challenging task because the warehouse receives inventory in various forms every day or every week, including new stock and returned items.

To maintain precise stock levels, tracking such frequent and substantial volumes of inventory is necessary. This can be quantified by recording the amount of time needed each time to receive, count, and store new inventory.

Picking Accuracy

Inventory and operations management run smoothly when the warehouse is organized. One of the most important and complicated tasks in order fulfillment is order picking.

Order selection errors result in misdirected packages, returned goods, and increased reverse logistics expenses.

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

Inventory Turnover Ratio

The number of times a business sells its inventory in a specific time frame is known as inventory turnover. The inventory turnover ratio provides insight into an organization’s sales-generating efficiency. The cost of goods sold is divided by the average inventory for the same accounting period to get the inventory turnover ratio. As an illustration, suppose that the average inventory is $10,000 and the cost of goods sold is $100,000. Then, divide both figures by ten. You can find the inventory turnover period using the inventory turnover ratio. If the turnover period is 365 days, then 36.5 is the result of dividing 365 by 10. 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 = 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.

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.

Carrying Cost of Inventory

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