Supply chain management metrics are designed to give your company the analytical tools to assess the performance of each piece of the supply chain. The matrices should be straightforward to use, but aligned to specific business requirements. Three important matrices critical to effective supply chain management and bottom lines are: carrying cost of inventory, inventory to sales ratio, and inventory turnover.
Carrying Cost of Inventory
The carrying cost of inventory is one of the supply chain management metrics that measures the costs of keeping inventory, whether over the short- or long-term. Carrying cost of inventory can help you to determine expected profits on current inventory, and if more product, or less, is required to ensure income levels or to cover expenses. It can also impact more strategic decision-making like sourcing.
Each individual piece of inventory has an associated cost. The cost includes the total cost from actual storage and freight charges, to costs related to storage if applicable, for example labour and insurance costs, or perishability or obsolescence, to name a few. These costs add up to the cost of inventory per year, which is the total cost of inventory capital, service, storage and risk costs.
To compute the carrying cost of inventory metric, you plug numbers into the ratio for the inventory carrying rate (the cost of owning inventory per year) divided by the average inventory value.
Inventory to Sales Ratio
A crucial aspect of your supply chain management metrics is linking supply chain to current economic conditions and predicting how well a company will withstand an unexpected change in the economic forecast. The inventory to sales ratio — the dollar amount of inventory value divided by the dollar amount of the sales value — can do just that because inventories rise in good economic times, and fall in times of economic decline.
The ratio is calculated as the cost of goods sold divided by the average inventory (or sales divided by inventory), so the lower the ratio the more efficiently the inventory is being managed. When the ratio starts to rise, it can be indicative of declining sales, or the need to reduce the inventory.
This metric is linked to inventory turnover, discussed below, and when analyzed together, the two supply management matrices can provide you with a window into the company’s financial health.
In general terms, inventory turnover is one of the supply chain management metrics that determines the efficiency of the supply chain since it measures how quickly inventory is sold, and how many times over it is sold annually.
The importance of the inventory turnover ratio calculation is that it shows efficiency in two key areas of supply chain management: buying and sales. When inventory grows because of purchases, and cannot be moved quickly, it increases inventory carrying costs so efficient and accurate purchasing is key. And, inventory turnover reflects sales abilities.
The goal is to provide a higher inventory turnover rate to give an accurate useable number of inventory turnover days. You compute the ratio as cost of goods sold divided by the average inventory.
The average number of days that it takes for inventory turnover can also be calculated by dividing the time it takes by dividing 365 by the number of days it took to sell the inventory.
Understanding the relationship between inventory and bottom line is crucial to your supply chain management. With these three metrics, your company can easily and effectively measure profits on current inventory, gain a window into economic conditions, and assess your supply chain efficiency.