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Small Business Center

6 Inventory Metrics You Should Track and How to Do It

February 2, 2022

By Francesca Nicasio, Vend
www.vendhq.com

Imagine you’re running a retail store that always has the right products at the right time. You don’t deal with surplus inventory, and you never run out of the products your customers want. That’s the dream, isn’t it?

But the reality of inventory management isn’t so great. Stores often struggle with stock control, and problems like shrinkage, excess inventory and stockouts are common. Look, no silver bullet can fix your inventory management woes. But there is one practical step you can take to minimize stock control issues, and that is to look at your inventory data.

Why Track Your Inventory Management Metrics?

Tracking your stock control data and metrics on a continuous basis enables you to spot trends and gain insights that can help you make better decisions for your inventory. But what should you track, exactly?

1. GMROI

This stands for gross margin return on investment, and it tells you the amount of money you got back — i.e., ROI — for every dollar you spent on inventory. GMROI measures your profit return on the funds invested in your stock. It answers questions such as, “How many gross margin dollars did I make from my inventory investment?” or “For every dollar invested in inventory, how many dollars did I get back?”

The formula for figuring out your GMROI is gross margin / average inventory cost.

So let’s say a retail store has a gross margin of $55,000 and an average inventory cost of $30,000. Its GMROI is 1.83, and that means the store earns $1.83 for every dollar in inventory.

Once you’ve determined the GMROI of your products, go a step further and “work out how much profit you make as a proportion of your scarce resources.” That was the advice of Damon Shinnie when he was finance manager at Find Me a Gift. “For example, if you have limited space in your warehouse, what was the profit generated per square foot of storage space occupied? If you are short on cash, what was the profit generated per average value of stock held?” Knowing the answers to such questions will enable you to make better decisions when it comes to what products to stock up on or which items to discontinue.

2. Shrinkage

This refers to the difference between the amount of stock that you have on paper and the actual stock you have available. It’s a reduction in inventory that isn’t caused by legit sales. The common causes of shrinkage include employee theft, shoplifting, administrative errors and supplier fraud.

The formula for shrinkage is ending inventory value – physically counted inventory value.

Shrinkage can also be expressed as a percentage. That formula is shrinkage / sales x 100.

According to a survey by the National Retail Federation, the average inventory shrink as a percentage of sales was 1.38% in 2015. It’s important to note that data varies from one retail sector to the next. Grocery’s was 3.6%, specialty men’s and women’s apparel 1.2% and discount, mass merchandise or supercenter retailers 1.1%.

Measure shrinkage in your own store and see how you stack up against other retailers. This should give you an indication of how well your store is doing when it comes to inventory accuracy.

3. Sell-through rate

Sell through is the percentage of units sold versus the number of units that were available to be sold.

To calculate this metric, use the formula number of units sold / beginning inventory x 100.

Let’s say a bookstore received 500 copies of a thriller novel from the publisher and sold 95 books after a month. The book’s sell-through percentage is 19%. In some cases, the unsold merchandise will be returned to the manufacturer — or in the bookstore’s case, the publisher. Some stores can also tack on a discount on the items to improve the sell-through percentage.

4. Stock turn

Also known as inventory turnover, stock turn is the number of times stock is sold through or used in a given time period. In most cases, the higher the stock turn, the better it is for your store because it means you’re selling a lot of merchandise without stocking too much inventory.

The stock turn formula is cost of goods sold / average inventory.

Let’s say an apparel store’s average inventory is $25,000 and the cost of goods it sold in a 12-month period is $100,000. Its inventory turnover is 4.0, and this means that the store sold out of its inventory four times that year.

Having a high stock turn means you’re being efficient. As Bruce Clark, an associate professor of marketing at Northeastern University puts it, “We like big numbers here because that means we are efficient: We carry very little inventory to support a certain level of sales.”

How often should you look at stock turn? According to Clark, “Conventionally this is always calculated annually: If we sell $1 million dollars in goods annually on an average inventory of $100K, our inventory turn equals 10. This can be calculated for shorter time periods, as well, as long as the periods are consistent, [such as monthly sales divided by monthly average]. Businesses that are highly seasonal may want to look at shorter periods in particular, since inventory needs are very different in high seasons versus low.”

5. Product performance

Your top- and lowest-performing products should always be top of mind, so track this metric regularly. Being fully aware of your  product performance means you can stay on top of stock orders, merchandising and sales, among other things. What products should you stock up on? Which items need a promotional push? The only way to answer these questions is to know your product performance like the back of your hand.

Adam Watson, managing director at Hollywood Mirros, said that product performance is something he constantly tracks. “I look at my stock inventory every Monday morning, and the first thing I look at are my most profitable products. I apply the 80/20 rule, or Pareto principle, in that 20% of my product provide 80% of my profitability, so I focus on this 20% of products first.”

He added: “I work out how long it takes to receive the product from a supplier, the amount I sell in a week and the amount I currently have in stock. I usually keep 30 days worth of product in stock, as I have 30-day payment terms with suppliers, making this ideal for cash flow. Next, I look at dead inventory or slow movers that are overstocked. I then either improve my listing online or be more competitive on price.”

How to measure product performance: Tracking product performance should be fairly simple if your point-of-sale or retail management system has the right reporting capabilities, as most modern ones do. Look at your product and sales reports, and pay attention to things like which products have the most and least sales counts, as well as which items are driving the highest and lowest revenues.

6. Lost sales

When Vend first published this article, retail expert Chris Petersen of Integrated Marketing Solutions left a comment advising retailers to track lost sales. According to him, lost sales “can be estimated by the days a SKU is out of stock [multiplied by] the average or expected sales rate. Lost sales estimates form a good “counterbalance” metric to gauge if you are trying to run too lean on inventory, especially for top-selling SKUs.

You Know Your Metrics. Now What?

So you’ve familiarized yourself with different inventory measures. Great! How do you extract value from them? The short answer is to track and use these metrics. It’s important to regularly monitor your inventory numbers so you can incorporate them into your business decisions. Accomplishing this depends on your business and the tools you have. The best way to get the inventory insights you need is to automate how data is collected and analyzed in your business.

You can do this by using a POS or retail management system with strong reporting capabilities. If you’re using a modern POS or retail system, see if it has retail analytics capabilities or talk to your vendor about accessing the data and reports you need. Not using a modern POS or retail platform? You can use a program such as Excel to track your inventory and metrics. It’s not ideal, especially if you have an extensive catalog, but it’s far better than crunching the numbers manually or, worse, not tracking your metrics at all.

Make Smarter Decisions with the Right Inventory Metrics

Curious as to how you can apply data into your decision-making? Here are a few examples.

Merchandising and Marketing Your Products More Effectively

Looking at data like sell-through and stock turn will help you get a clear picture of your top-performing products, as well as which items aren’t moving off the shelves fast enough. From there, you can make decisions on how to merchandise your products in-store and how to sell them.

Take a look at what T-We Tea, a San Francisco-based retailer that sold house-made teas and accessories, did with its products. It noticed that its low-margin items like tea accessories were moving faster than their high-margin house-made teas, so it opted to group them together at a slightly lower price. As a result, they were able to move products faster while maximizing profits at the same time.

Planning What Items to Order and When

Knowing how fast a style is moving or how much return you’re getting out of a product can help you plan out your inventory ordering. For instance, if you discover that an item sells out every couple of months or so, then you can plan out how often you should be ordering that SKU. On the other hand, knowing your GMROI for different products can give you a better idea of which items are worth investing in and how much you should spend on them.

Improving Your Processes

Measuring metrics such as shrinkage doesn’t just help you measure inventory losses, but it can also give you valuable insights for improving your store procedures and security. If your inventory discrepancies and losses are quite large, perhaps you need to set better user permissions that restrict employees from seeing information or performing tasks outside their job description.

You can also drill down on shrink by category or store area. Let’s say shrinkage is a lot higher in a particular department than an the rest of the shop. Armed with this information, you can take a closer look at that department to figure out the reason behind high shrinkage. Are the items more prone to shoplifting? Are the products located in an area that can’t be monitored by your staff? The only way to find out is to look at the data and investigate.

Here’s another example. Let’s say you discovered that administrative errors — e.g., pricing errors, mistakes in markups or markdowns — are causing major discrepancies in your inventory records. You can use that information to start improving how tasks are carried out in your stores. You can, for example, automate certain jobs to reduce human error.

Remember, the Lack of Knowledge Is Expensive

We’ve all heard the cliche knowledge is power. It’s a compelling statement, but just as powerful is the fact that the lack of knowledge is expensive. This couldn’t be truer in the world of retail. If you don’t know your numbers around inventory or if you’re not aware of what your customers like and dislike, then you could be losing a lot of money. If you fail to make the right decisions around merchandising, marketing and customer service, you’ll end up losing customers and missing out on revenue opportunities.

Don’t let that happen to you. Start tracking your retail numbers. Only then will you be able to truly figure out what’s going on in your business.

This article was originally published at www.vendhq.com.

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