Are you losing money because your stock is sitting in your warehouse for too long?
Do you have problems with low turnover and obsolete inventory?
Wondering if you can avoid these types of problems in the future?
In this article, we want to introduce you to the most vital wholesale inventory metrics you should be tracking. Our goal is to help you increase your business's profit margin.
You may already be tracking some metrics, or KPIs (key performance indicators), or you may be in reactive mode constantly. To increase your productivity, you should be checking for everything you see here. Constant measurement and improvement is the only way to bring your wholesale business to the next level.
Read on to learn the top 7 inventory metrics your wholesale business needs to be tracking.
1. Gross Margin Return on Investment
Gross Margin Return on Investment (GMROI) tells you how productively your business is turning inventory into gross profit. It is one of the most important inventory profitability ratios. A GMROI ratio greater than 1 indicates that you are selling your inventory at a price higher than its acquisition cost. The higher the GMROI, the greater the profitability and an indicator of inventory efficiency.
To calculate your GMROI, divide your gross margin by the average inventory cost.
If you have a GMROI of 1.57, this indicates that you are getting back $1.57 in gross profit for every $1 invested in your inventory.
Most companies aim to achieve a GMROI greater than 1, meaning that sales of your inventory are profitable. However, a point to note is that there is no “right number” for what your GMROI should be. Every wholesale business is unique, customer types, product prices, and margins can vary widely. They key is to measure your productivity and work on improving it.
With this metric, you can analyze which products, categories of goods and departments are the most productive in generating profit for your business.
2. Contribution Margin
Contribution Margin is your products’ selling price minus variable costs. It measures your ability to cover fixed costs with sales. This metric can be used for individual product or entire product lines. For your catalog, looking at your products’ contribution margins can enable you to pinpoint which of your products are less profitable than others.
To calculate your contribution margin, you first need to identify your variable costs. It’s important to remember that contribution margin is not gross margin, which is calculated by taking revenue and subtracting the cost of goods sold (COGS). Variable costs are costs which change when you produce (or source) more or less product quantity. For example, raw materials and sales commissions are typically variable costs. Once you have identified variable costs, subtract those from the total revenue to find contribution margin.
Analyzing the contribution margin helps managers in making decisions like whether to add or subtract a product line to pricing your goods to structuring your sales commissions. If your product's contribution margin is negative, you should either remove the product or increase your prices as your business is losing money with each unit produced. On the other hand, if your product has a positive contribution margin, it is probably worth keeping that product line.
3. Perfect Order Rate
One key parameter to start monitoring is the number of orders which are leaving your warehouse without incident, where an incident includes damaged goods, inaccurate orders or late shipments. This is known throughout the industry as the Perfect Order Rate.
So how do you calculate your perfect order rate? First, take the total number of orders and subtract the number of orders that have errors. For most business, an order is deemed to have an error if your order is:
- Delivered to the wrong location
- Delivered the wrong products
- Delivered an incorrect quantity of products
- Delivered damaged goods to customers
- Reached the customer late
- Sent incorrect invoice
- Sent inaccurate documents
Next, divide that figure by the total number of orders and multiply by 100 to give you the perfect order management.
According to APAC, top performing companies have a perfect order rate of 95% with the worst performing companies having a perfect order rate of 82%. The median was 90%.
This metric is a good starting point for your business to understand whether a problem exists. Then, you can take the additional step to categorize the reasons each order is not “perfect” and you’ll begin to gain detailed insight into the root of your problems. Perhaps you need to undergo an audit of your transportation and shipping? Or, the problem could lie with your pickers and shippers. Once you have found the root cause of the problems, you can take steps to improve your perfect order rate.
4. Inventory Turnover
Inventory turnover shows how effective your business is at managing inventory. By comparing the cost of goods sold with the average inventory for a period, typically a year, you can determine how quickly you are turning over inventory, i.e., your inventory turnover ratio. The faster the inventory turnover is, the more efficient your business, and the higher returns the business can expect from its assets.
So why is this KPI important? Inventory turnover depends on two main performance components. The first component is stock purchasing. If a business purchases large quantities of inventory during the year, it would have to sell a higher amount of inventory to improve its turnover. In the event that the company cannot sell its inventory, these would lead to higher storage and holding costs.
The second component is sales. If sales are unable to match inventory purchases, business performance overall will suffer. Thus, the purchasing and sales teams need to work together and be in sync.
To calculate your inventory turnover, divide the cost of goods sold by your average inventory. Your average inventory can be found by dividing the sum of your beginning and ending inventory in half.
On average, most wholesalers aim for eight to nine full inventory turnover per year.
By doing diligence audits for your turnovers, you ensure that your warehouse space is not wasted on products that are not selling quickly.
This metric might seem insignificant, but it can have enormous repercussions for your business. In fact, about 20 to 30% of a company's inventory is often dead or obsolete. For the food industry in the United States alone, food waste costs businesses more than $650 million a year.
Inventory turnover ratio is especially useful at the start of a major overhaul to understand if there is a severe problem with obsolete inventory. By keeping track of how much inventory is wasted, you can take steps to reduce errors and save time for your business.
5. Days Sales Of Inventory
Days sales of inventory (DSI), also commonly known as days inventory outstanding, measures the number of days it takes for a business to sell all of its inventory. This helps to measure the effectiveness of inventory management by showing how long can the business's current inventory last.
The difference between inventory turnover and DSI is that inventory turnover focuses on average inventory, DSI focuses on ending inventory.
To calculate DSI, you would divide the ending inventory by the cost of goods sold for that period and multiply it by 365.
In general, your DSI should be as low as possible. A low DSI is an indicator that your business has been effective in using its inventory. Businesses always aim to sell their inventory as fast as possible, in hopes of minimizing storage costs and increasing cash flow.
6. Cash To Cash Cycle
Cash to cash cycle, also known as the cash conversion cycle, is the period between the time you purchase raw materials from your suppliers to when you receive cash from your customers.
This metric helps determine the amount of cash needed to fund your day-to-day operations and is often used to estimate financing requirements.
The formula to calculate this metric is (days inventory on hand + days sales outstanding - days payables outstanding).
If a company has 20 cash to cash days, this means that your business needs to be able to support its expenditure for 20 days.
A report by APQC found that top businesses performers have a cash to cash cycle of 30 days compared to bottom performers which takes 80 days. The median was found to be 45. However, this number varies quite significantly from industry to industry and this figure should only be used as a benchmark.
The shorter the cash to cash cycle, the faster your business can turn inventory into cash. The faster you can recover your initial investment, the more capital you will have on hand and the more products you can produce and increase your revenue. Depending on the results, here are a few steps you can take to reduce your cash to cash cycle time.
1. Reducing the amount of on-hand inventory
2. Lowering credit to customers
3. Requiring customers to make payment upfront
4. Re-negotiating longer payment terms with your suppliers
7. Turn-Earn Index
Turn-earn index (TEI) is the ratio that analyzes inventory turnover and gross margin. The TEI is useful in inventory management as it helps you to evaluate your entire inventory or a single SKU to determine if is worth stocking it or selling it.
To calculate your TEI, you would simply multiply your inventory turnover with your gross margin.
Most companies aim for a minimum index of 100 to 180. However, this number varies from industry to industry and depends on if you are a wholesaler, manufacturer or distributor.
TEI helps companies gain deeper insight into their operations when compared to inventory turnover alone. While companies want to get rid of inventory as fast as possible, a product might have a low turnover but could be profitable if it has a high gross margin. The margins could be high enough to justify its low inventory turnover and high storage costs.
Once you have identified which metrics are most appropriate for your business, you can start measuring them by creating benchmarks to find out how your business is doing.
Every business is different so benchmarks you find online may need be the right ones for you to measure your business against. It is up to you to decide which metrics are essential to reach your goals. As your business grows, you may need to tweak your reporting process to help you take your business to the next level.
Lastly, tracking inventory data and collating reports are often time-consuming, and most businesses do not have time to do so. Sweet offers a scalable solution to help you manage your wholesale inventory data and has automated reporting features to help you track your business growth. Sweet is a fully integrated order and inventory management software that works with business with all sizes.
To find out if Sweet is the right fit for your wholesale business, request a free demo today.