If a large proportion of your total assets are held up in inventory, it is essential to know how well it is contributing to your bottom line. To answer that question, you’re going to need to crunch some numbers.
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By tracking your inventory’s ROI on a regular basis, you can quickly spot issues as well as trends and, ultimately, gain insights that will help you to make more informed decisions in the future. But what metrics should you measure?
The gross margin return on investment (GMROI) calculation essentially does what it says on the tin – it tells you the amount of money you got back for every pound you invested.
Formula: Gross Profit / Average Inventory Cost
Example: Say you generate a gross profit of £300,000 in a year with an average inventory cost of £210,000. Your GMROI would be 1.42, meaning for every pound spent, you earned £1.42.
To improve your GMROI, the simplest ways are to increase your prices or reduce the amount you pay for goods – though we know this is normally much more complicated than it sounds!
Measuring your sell-through is a great way to determine how your products are performing, giving you a clear idea of how quickly you’re selling a product over a given period.
Formula: Number of Units Sold / Beginning Inventory X 100
Example: Say you had a delivery of 500 apples and you sold 280 in the first two days. Your sell-through would indicate that you’d sold 56% of your inventory.
Your sell-through is a key indication of how much of a product you should purchase to meet future demand. A high sell-through will likely signal the need for a restock before you run out, while a low sell-through tells you a product isn’t selling fast enough and that you may need to look at lowering the price or adding incentives or promotions to push it.
While not necessarily your typical mathematical calculation, the performance of your products should always be one of the most important metrics you measure. Being fully aware means you’ll know what you should stock up on and what items may need a push.
How to measure: An efficient POS or inventory management system will make tracking product performance quick and easy. You’ll be able to monitor real-time reports and identify which items drive the highest and lowest sales.
Shrinkage will indicate reductions in inventory that are not as a result of general sales. Typically, this will be due to administrative errors, employee theft or shoplifting.
Formula: Ending Inventory Value – Counted Inventory Value
Example: If you’re inventory value was £100,000 on paper but only £98,500 when counted, you’re down £1,500 or 1.5%.
Closely tracking shrinkage gives you clear visibility over your inventory and will enable you to come up with solutions to prevent it. How you do so depends on the source. You may want to introduce stricter security measures if theft becomes a problem or maybe automate your inventory management processes if there are numerous admin errors.
Your inventory turnover calculates the number of times products have been sold, typically over the course of a year, and is a key measurement of your overall business performance.
Formula: Cost of Goods Sold / Average Inventory
Example: Say the cost of goods sold in one year was £200,000 and your average inventory was at £50,000. Your inventory turnover would be 4, meaning you sold out of your inventory four times that year.
In most cases, the higher the turnover, the more efficient your sales process is. If you have a low turnover, you’re likely to face high storage costs and the possibility that the product will become obsolete. To resolve this, look into organising promotions to shift the inventory you have now and switch to a ‘little and often’ method of purchasing to reduce the risk of losing money on products that you’re not sure will sell.
So, now you know your metrics, it’s important to actually track and use them. The simplest way to do so is to automate your business processes into one system. At KC Smart Stock, we specialise in providing integrated inventory management solutions. Just fill out the form at the top of this page to find out how we could help.