Small business owners know that inventory costs money, but not all are proactive enough to establish where these costs come from and how to measure their impact. Inventory is a company asset. As such, it must be managed with respect to several criteria. When small businesses look to measure their performance with respect to inventory management, they must establish their key performance indicators, commonly referred to as KPI. These key performance indicators allow small businesses to not only better manage their inventory, but to better establish the priorities within their inventory management practices. In addition, these performance indicators are also used to measure how well inventory managers isolate costs and mitigate their effects. So, what are the 5 key performance indicators with respect to small business inventory management?
Monthly Inventory Value
We’ll start with the most recognized inventory KPI. In this case, the value of a company’s inventory at the end of the month is a strong indicator of the company’s ability to match its inventory levels to its manufacturing needs and sales forecasts. Small businesses must adhere to stringent limits on the value of inventory within a given month. Some businesses extend this KPI to analyzing the inventory value over a quarter. This requires companies set limits on inventory value relative to their market or industry’s fluctuating demands.
Value of Raw Material & Part Consumption
One of the key performance indicators for small manufacturers must include inventory’s ability to match raw material & part consumption with manufacturing’s requirements. In this case the approach is to measure the continued supply of these materials and parts and to ensure no production delays occur because of a lack of supply. The KPI in this case would measure the incidence and duration of a delay caused by a lack of available materials & parts.
Incidence of “Out of Stock” (OOS)
Similar to the KPI for raw material & part consumption, the incidence of “stock-outs” is also a key performance indicator. However, in this case, it’s the measurement of the lack of finished product inventory needed for current sales. The question therefore becomes, how many times have customer orders been unfulfilled because of a lack of available inventory of finished product? Understanding this KPI involves measuring the length of time of the stock-out and its impact on costs. Has the company had to incur expedited freight costs to rush parts and materials in? If so, that will not only impact his KPI, but the aforementioned raw material & part consumption KPI.
Value of Obsolete & Damaged Inventory
This KPI measures the costs relative to obsolete and damaged inventory. Small businesses must set goals and objectives predicated on controlling the incidence of damaged inventory caused by poor handling. Reducing the impact of obsolete & damaged inventory will allow the small business to reduce inventory costs. In most cases, damaged inventory can only be sold as scrap. Regardless of a company’s business model, all should have this as a one of their key performance indicators within their inventory management practices. Most companies immediately identify those products likely to become obsolete and take proactive measures to immediately liquidate that inventory.
Incidence of Product Returns
One of the most important inventory key performance indicators includes the incidence of products returned by RMA (return material authorization). In this case, the cost is twofold. One is the original cost to purchase parts and materials to manufacture these products. The other is the cost to take these products back. This often involves paying for freight if the company is liable for defective product. While this is an inventory key performance indicator, it can easily apply to several departments within a small business. Sales may have quoted the wrong part. Customer service may have entered the wrong part in order entry, and the shipping department may have accidentally shipped the wrong part.
Regardless of the size of your company, taking the time to establish these key performance indicators will lead to more efficient inventory management practices. The focus is on identifying those costs that impact a company’s gross profit and ultimately, its bottom line. When setting these key performance indicators, be sure to match them to your company’s business model and approach. If your business is built on cyclical and seasonal customer demand patterns, then perhaps the first key performance indicator on monthly inventory value should be extended to measuring inventory value by quarter. Whatever the case, key performance indicators allow companies to immediately identify issues of concern and be proactive in addressing them.