Inventory Analysis: Tips, Methods and KPIs

Inventory analysis helps a company understand how to fill customer orders while keeping inventory costs low. We provide tips and the formulas and key metrics you need to analyse your company’s inventory.

What Is Inventory Analysis?

Inventory analysis helps you determine the right amount of stock to keep on-hand to fill demand while avoiding spending too much on inventory storage.

Inventory is an asset on a balance sheet and represents the product a company plans to sell to its customers eventually. In addition to finished goods, inventory includes the raw materials needed to produce those goods and work-in-progress goods (a washing machine that workers are assembling, for example).

Goals of Inventory Analysis

The goals of inventory analysis include lowering costs, reducing theft, managing cash flow and ensuring you always have the goods available that customers want to buy.

Here are more details on some primary goals of inventory analysis:

• Increase Profits:
  Keeping the right amount of inventory on hand to grow sales while reducing expenses will increase profits.

• Decrease Storage and Related Expenses:
  Avoid keeping more inventory on hand than you need, which will lower storage and related costs. (To learn more about inventory control, read the Essential Guide to Inventory Control.)

• Reduce Capital Costs:
  When you avoid buying too much inventory, you retain more cash and capital for other investments.

• Improve Cashflow:
  Having the goods customers want to purchase increases cash flow.

• Find Areas to Improve:
  Closely watching inventory helps you identify products that are selling exceptionally well or poorly. Understanding this dynamic can free up shelf space and improve supplier relationships.

• Minimise Stockouts and Backorders:
  When you don’t have a product to deliver to a customer who wants to buy it, that creates an unhappy customer who may have to wait for it on backorder — or even buy it from a competitor.

• Stop Project Delays:
  When using inventory to build products for a special project, an inventory analysis tracks the stock needed. Use this information to make sure there’s enough lead time to reorder that inventory, so you don’t run out of materials and delay a project.

• Diminish Wasted Inventory:
  If you buy and store too much product, it can turn into a loss when it becomes obsolete, degraded or otherwise loses its value. Perform an inventory analysis to prevent that from happening.

Types of Inventory

The four primary types of inventory are raw materials, work-in-progress goods, finished goods and maintenance, repair and operating supplies (MRO).

How Do You Analyse Inventory

Companies use stock and sales numbers to analyse inventory. Experts also use ratios and metrics — sometimes known as key performance indicators (KPIs) — to see how well an organisation manages its stock.

Inventory Analysis Techniques

There are several methods you can use to perform your inventory analysis. The best way to do it depends on your industry and your inventory type. Here are the most common techniques or methods and the industries that use them:

• ABC Analysis:
  ABC Analysis is the most popular inventory analysis method (especially for retail) ranks inventory from the highest revenue and profit margins to the lowest using three buckets: A, B and C.

• VED Analysis:
  This method is based on how vital it is to have an inventory item in stock. Manufacturing companies use this technique to assess the components and parts they must have on hand. With this analysis, they measure inventory based on:

  • Vital: Inventory that must always be in stock at sufficient levels
  • Essential: Have at least a small number of these items in inventory
  • Desirable: It’s not critical to always have these items on hand

• HML Analysis:
  Often used in manufacturing, this analysis measures the inventory based on high, medium and low cost.

  The accounting cost of inventory also depends on whether a company uses Last in, First Out (LIFO) or First in First Out (FIFO) accounting. LIFO companies sell the inventory first that they bought last. FIFO companies sell the inventory first that they bought first. In First Expire, First Out (FEFO), expiration dates drive the sales, with companies exhausting the stock with the earliest expiration date first. To learn more about LIFO, FIFO and other cost accounting methods, read The Key to Using Inventory Cost Accounting Methods in Your Business.

• SDE Analysis:
  This inventory analysis method considers how scarce an item is and how easily you can acquire it. This technique often involves components that make up a manufactured good. With this analysis, a company measures inventory based on:

  • Scarce: A component that is scarce and takes a while to get
  • Difficult: A part that is less scarce but still may take several weeks to arrive
  • Easily Available: Components that are easy to acquire

  For example, a furniture manufacturer might make a dining room table using marble inlays available from only one supplier. The manufacturer would track that inventory (scarce) differently than the unique wood components for the top of the table (difficult) or the screws that hold the table together (easily available).

• Material Requirements Planning (MRP):
  In this method, manufacturers order inventory based on sales forecasts and stock data from various areas of the company. So, a company that manufactures swimwear will order more inventory in the months before demand increases.

• Economic Order Quantity (EOQ):
  This method assesses the sales rate for an item, along with its ordering costs and storage costs. Using these three variables, EOQ determines how often and how much the company should order. The goal is to keep the ordering and storage costs as low as possible while still meeting all customer orders. Learn more about EOQ in our inventory forecasting guide.

• Fast, Slow and Non-moving (FSN):
  In this approach, the company categorises inventory into three buckets: fast-moving, slow-moving and non-moving inventory. Managers assess the inventory and make new stock purchases based on the category. Companies using FSN re-order fast-moving inventory most often.

• Custom Par Levels:
  This analysis sets an inventory amount at which the company must re-order each item. This technique requires extra work at the beginning of the process but can ensure an organisation rarely runs out of stock.

How Do You Choose Which Inventory Analysis Technique to Use?

The inventory analysis technique that works best for your company depends on your industry and type of work. Some methods are ideal for retail sales, for example. Others are better for manufacturing.

Check the effectiveness of a technique after using it for a while. Is your company experiencing fewer stockouts? Are you lowering storage costs for unsold inventory because of how you’re analysing and managing inventory?

Key Inventory Analysis Metrics

Sometimes called KPIs, use these metrics to analyse how your company handles inventory. Popular metrics include turnover rate, available to promise, stockout rate and sell-through rate.

Gross Margin Return on Invested Inventory (GMROI)

Retail businesses use this formula to see how well they are turning inventory into profits.

The formula is:

GMROI = Gross profit margin / average cost of inventory on hand

Your final result should be above 1.0.

Available to Promise (ATP)

This formula provides insights into the product a company has or will have to fulfil customer orders. A company uses the result to quote a delivery date to a customer.

The formula is:

ATP = Quantity of product on hand + supply (or planned orders) – demand (or sales orders)

Inventory Turnover Rate

The inventory turnover rate measures how many times a company has sold its average stock in a specific period. An indicator of how well you’re managing inventory, the formula also reveals how your products are selling.

The formula is:

ITR = Cost of goods sold (COGS) during specified period / Average inventory during the period

Stockout Rate

This KPI measures how often an item a customer orders is not available. You want this number, expressed as a percentage, to be below 10% and as close to zero as possible. That’s especially true for a company’s most popular items.

The formula is:

SR = (Stockout order / total customer orders) x 100

Customer Service Level (CSL)

Use the CSL to measure the probability of not having a stockout, and thus a lost sale, during a specified period. The calculation is expressed as a percentage.

The formula is:

CSL = (Products delivered on time / total products sold) x 100

Average Days to Sell Inventory, Days Sale of Inventory (DSI) or Days on Hand

This KPI measures how many days on average it takes a company to sell an item. Use the formula to see how quickly a company turns inventory into sales revenue. A lower number shows a more efficient operation.

There are two possible formulas for this:

ADS or DSI = (Average inventory value in a year / cost of goods sold in the year) x 365

ADS or DSI = 365 x Inventory turnover ratio

Sell-Through Rate

This calculation measures how much of an item you’ve sold during a period compared to how many items you received in inventory. This KPI is critical in the retail industry and expressed as a percentage.

The formula is:

STR = (Total sales during period / inventory received during the period) x 100

Back Order Rate

This KPI measures what portion of your customers’ total orders are for items that are back ordered, which means a delay in delivery. Express a back order as a percentage.

The formula is:

Back order rate = (Total back orders / total orders) x 100

Qualitative Analysis of Inventory

Companies will want to analyse their inventory beyond set KPIs and consider other practices that are crucial to managing inventory effectively. These include:

Just-in-Time (JIT) Ordering

In JIT ordering, a company keeps just enough inventory to fulfil all customer orders. While the company saves significantly on storage and related costs, it requires careful planning to receive materials and products on time.

Order Fulfilment Philosophy

To have a consistently quick turnaround for orders of popular products, a company will keep a large amount of those goods in inventory.

Inventory Obsolescence

In some industries, like beauty and fashion, goods hold value for a limited time. These companies need to limit their inventory for products that become obsolete and unsellable (aka inventory obsolescence).

Cash Availability

Some companies have limited cash and can’t get financing for more, which may limit how much they spend on inventory.

How Inventory Management Systems Help With Inventory Analysis

Inventory management systems can help a company manage stock levels to satisfy customers and lower inventory costs. These systems can track goods from the moment a company orders it to when it arrives in a customer’s hands.

Choosing Software to Help with Inventory Analysis

Inventory analysis informs critical business decisions that can affect everything from how much stock you keep on-hand to profitability. That’s why having a tool that can automate the process and deliver results in real time is essential.

NetSuite offers a range of features to help you manage inventory. Use our inventory management system to track stock in multiple locations, establish re-order points and ensure the right inventory is at the right place and at the right time.

Learn more about NetSuite’s inventory management software.

Inventory Analysis FAQs

In this section, we address other questions related to inventory analysis beyond KPIs and methodologies.

What Is an Inventory Analyst?

Also called purchasing managers, inventory analysts analyse and manage a company’s inventory. They understand their company’s sales, expenses and industry trends. Their job is to help a company manage inventory to save money.

What Is an Inventory Write-Off?

An inventory write-off is the amount of stock a business decides no longer has value. That could be due to spoilage, damage or because the inventory is obsolete. The write-off is the accounting dollar amount that shows that loss.

What Are Holding Costs?

Holding costs are what it costs a company to store inventory. Costs include storing the stock, insurance, equipment and labour expenses associated with managing the inventory.

What Is Average Inventory?

Average inventory is the amount of stock a company holds over a period. To get average inventory, add the amount of inventory at the beginning and end of a period and divide by two.

How to Present an Inventory Analysis?

An inventory analysis should include data on the amount of stock from one period to the next. Present metrics to show how well your company is managing its inventory in the analysis.