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Essential Entrepreneur KPIs for Inventory Management

written by: Ian Johnson•edited by: Ginny Edwards•updated: 3/14/2011

Establishing a company's KPIs for inventory management is an essential aspect of properly identifying inventory costs, and putting plans in motion to reduce those costs.

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    When entrepreneurs look to assess their inventory costs, a number of them assume those costs are relegated to the purchase price on parts and materials. Unfortunately, there are a number of other factors that should be considered with respect to the costs of inventory. To this extent, we’re discussing key performance indicators, or KPIs. So, what are the essential KPIs for inventory management?

    Companies rely upon these performance indicators in order to assess and establish their total cost of ownership, and ultimately to enact strategies that reduce these costs. As such, KPIs for inventory management must be structured around providing entrepreneurs with a wider perspective of the costs to purchase and hold inventory over extended periods. KPIs provide companies with insight into how well their inventory is being managed, and how effective those aforementioned strategies are. Therefore, the question remains, what are the most common and essential inventory key performance indicators?

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    1. Obsolete Inventory Value

    Morgue File: duboix 

    Entrepreneurs must be cognizant of the costs of obsolete, damaged and outdated inventory. In most cases, this inventory must be liquidated at a reduced price, or sold as scrap. The most progressive companies track the incidence of damage in order to enact strategic plans to reduce mishandling. However, this is one key performance indicator that is also tied to sales forecasting accuracy. Since sales drives inventory, sales must ensure they are forecasting those products most likely to be sold. As such, companies use this KPI in order to assess their inventory management practices and the effectiveness of their sales forecasts.

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    2. Month End Inventory Value

    When it comes to discussing KPIs for inventory management, no list would ever be complete without discussing month end inventory values. Every entrepreneur must track their inventory values on a monthly basis relative to their finished inventory, semi-finished inventory as well as their part and raw material costs. The focus is on mitigating these costs to better manage inventory, and to better manage cash flow. Limit the amount purchased within a given month and the company will have lower payables. However, the onus goes far beyond not ordering too much inventory. Instead, it’s on matching inventory levels with the company’s requirements. This leads us to the third key performance indicator.

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    3. Consumption of Raw Materials

    This inventory KPI is more ideally suited to manufacturers. In this case, the approach is to ensure that the company’s inventory levels are never so low as to be the reason for downtime in manufacturing. It’s a difficult KPI for sure! However, to be able to guarantee the company has just enough parts & raw materials to keep machines running, but not so much inventory that the costs are too high, is the truest indicator that a company’s inventory is being managed properly. For this KPI to be relevant, entrepreneurs must establish limits on raw materials and provide leniency when measuring the amount of inventory in a given month.

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    4. Occurrence of Stock Outs

    Companies need sales in order to capture market share, grow their business and incentivize customers to return. Without inventory, that simply doesn’t happen. One of the more essential KPIs for inventory management is the incidence of stock-outs. This is not to be confused with the third item on the list which concerns the steady supply of raw materials to manufacturing. In this case, the discussion focuses on finished product inventory and the ability of inventory managers to provide sales with forecasted product. Stock outs are killers for sales and this is but another KPI that often forces a company’s inventory management and sales to work closer together.

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    5. Per-Unit Freight Costs on Raw Materials & Parts

    A number of small businesses ignore this KPI completely. A company’s cost of ownership includes not only the costs to hold that inventory, but the costs of getting that inventory into the warehouse. In this case we’re discussing the per-unit freight costs on incoming parts and raw materials. This is an extremely important cost with respect to managing inventory. Reduce these costs and the company has effectively reduced its overall inventory cost of ownership.

    When looking at KPIs for inventory management, entrepreneurs should keep it simple and straightforward. The smaller the enterprise, the easier it is to track these performance indicators. It’s essential that a company’s key performance indicators match the company’s business model and approach to market. As such, keep it simple and the process to reducing costs will become simple as well.

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    Calculator courtesy of duboix at Morgue File:

    Source: author’s own experience.