I am going to try and write an article that covers both retailers and wholesalers. The principles that drive both business types, are generally about the same. The biggest difference is that retail tends to change with consumer buying habits a lot quicker. In saying that wholesalers that provide products that follow trends are also in a similar boat. I am thinking of fashion/apparel, food products, consumer electronics, and so forth. However, if you are not in these industries, I still think you will garnish a lot of value out of this article.
In my experience, I have come across a lot of different KPI’s and dashboards that look quite fancy, but seemed to provide little useful information that is quite pointless, and didn’t really lend itself to making key decisions.
Before I get into the actual KPI’s, I think it’s important to identify, what questions you need to ask as a retailer and wholesaler. I narrowed down the questions required per product on an ongoing basis, this isn’t an exhaustive list, but distilled down to the most essential:
- Is the price correct? Increase in price? Decrease?
- Have I got the right amount of stock? Need more or less?
- Don’t change anything, it’s perfect? Ie right price, correct SOH.
If you can answer these simple questions per product line/variation on an ongoing basis, in the ideal world you would have the perfect product based business. Trying to do this one product at a time, if you have 1000’s of products would be quite difficult, especially if you have an older type system, or even still trying to just manage it all on with a manual system. Trust me, I have had multi-million dollar clients, that sell products, that manage the whole process on paper and excel. Albeit they weren’t that efficient, but they did do remarkably well considering the tools at their disposal.
To answer the above questions, you will need a number of KPI’s that I believe are important to be able to make the right decision. The KPI’s we are going to look at in this article are:
- Days of Supply
- Stock to Sales Ratio
- Cost of Carrying Inventory
In next months issue we will cover some further metrics
- Sell through percentage
- Gross margin return on investment
So what is days of supply? The phrase gets bandied around a lot, but not many people really know what it means. Well in simple terms it means how long will it take to sell out of present stock, assuming sales continue at the same rate as recent sales have been. This is weighed against a time frame like 30,60 or 120 days. If its in a highly seasonal time, you can change that average to be 7,14 or 30 days, so that you can make more accurate assumptions. It is one of the simplest statistics, for predicting the future. Your own little crystal ball to predict what you will need to order.
Let me illustrate the point by giving you an example.
Lets say you have 100 black polo shirts currently in stock, and in the last 30 days you have sold 45. How many more days stock do you have left?
45(sales)/30days = 1.5 Black Polo Shirts sold per day.
Current Stock = 100
Days of Supply left = 100 (present Stock)/1.5sold per day = 66.67 days of supply left.
So how do you use this information?
Well to best put this to use, you will need to understand the seasonal nature of your product. If it is in season, you will want to make the weighted time frame shorter, however, if it is out of season you would obviously have a longer period. The other practical side of this is ensuring your supply days don’t exceed your lead time. Using the above example, we have approximately 67 days of stock left, but if your lead time is 70 days, you are running the gauntlet. You do not want your DOS to be greater than your lead time.
So its probably quite important to have a metric that calculates your DOS, and then contrasts it against lead times. This would potentially flag understocked, and overstocked items, and against lead times, would run a red flag, against stock that might need to be urgently delivered into your warehouse or retail outlet.
Turn is how many times an individual inventory item is replaced in the course of a year. So in essence what your average stock level is and how many times per year that amount is sold out and restocked. This is an important statistic to monitor, as it will tell you when to order, how much to order, what to sell and price to sell at.
I was a financial controller at a large bearings importer in Sydney. They had a very large amount of stock, somewhere in the vicinity of ten millions dollars or so. However, they have a turn of around 1.5. Now obviously, if you drilled down to the individual items, there would be some products that did have a significantly higher turn, and some were simply not moving. The problem with this was a large majority of the stock, and the 80/20 rule seemed to apply, was catatonic, which meant that almost eight million dollars in stock was very slow moving and the bigger problem was that precious money was tied to this stock and could not be reinvested into other areas of the business or other investment options.
Let me illustrate this point below.
Lets say on average we keep 100 toy cars in stock, and we sell 100 of these toy cars every 4 months. So that would mean you would sell 300 toy cars annually.
Turn = Annual Sales/Average SOH ((beginning inventory + ending inventory)/2)
Turn = 300/100 = 3
Which means you would turn over that item 3 times a year. Traditionally the higher the better, the mean point being around 6, greater than six and the product is doing well. Below 6 and approaching 0 is problematic.
The implications are this, to move stock often pricing discounts need to implemented to encourage people to purchase more. This isn’t ideal but if you have a stock item with a very low turn, eventually this item might become obsolete, and if its a food item, or something with a useful shelf life, it will become worthless to you and you will not be able to recover any of your money.
Now there is a myriad of uses for this and I have illustrated just one, but in combination with days of supply report, you can become a lot smarter about what you order, and how much you re-order. Get this right and you will not only free up precious capital, but you will make your warehouse carrying costs less as well.
Stock to Sales Ratio
Stock to sales ratio is a key statistic for measuring whether or not you are overstocked and understocked. Any manager wants to know what they are over/understocked. So in a nutshell for every unit sold, how many units were on hand. Simplified, if you had 30 dress shirts in the storeroom when you sold 10 out of the 30, then you know in order to sell 10 dress shirts, you would always have to have 30 of those dress shirt in the storeroom.
Just recently I did a client install, where a staff member, who was going to resign, thought it would be a good idea to order quite a lot of stock, to tide over the owner, in case the new person wasn’t ofay with the task at hand. However, she wasn’t very wise, and did not understand key statistics, and ended up overstocking a lot of products. The person who was slotted in for her position, ended up not committing to the position, and she ended up taking the position again. With putting in the new system, it became glaringly obvious, some stock was quite heavily overstocked, and the owner wasn’t too thrilled about the situation.
That being said, let me give you an example, so you can better understand the statistic.
Using the example mentioned above, 30 shirts average stock, to sell 10 shirts. Give you a 3:1 ratio. That tells you to sell 10 shirts you seem to need to hold on average 30 shirts.
Now you might think that’s a rather strange metric, and its a bit of a pie in the sky type of statistic, but the reality when you work with products, there is a phenomenon that occurs when a customer walks into your shop or calls in regards to a stock query, and you let them know that you have minimal stock on an item, its almost unspoken, but customers assume you have a poor idea of what stock you need as a business and would prefer going to a supplier that is carrying all they want.
The inverse is also true, when you have everything, it gives the customer confidence. But then you could go the other way, and grossly overstock, and tie $$$$ that could be used in other areas. So understanding the stock to sales ratio, in tandem with DOS, and Turn helps you get closer to getting it right.
Cost of carrying Inventory
It should be quite straight forward to get your average inventory value, if you have a inventory management system, if not it might be quite cumbersome and a long drawn out process, that might not be too accurate.
The more complex calculation is the inventory carry costs, this rate requires that you pay careful attention to the cost of carrying inventory. I will use a hypothetical example to assist you in this calculation.
Add up your annual inventory costs
Storage – $80k
Handling(staff, logisitcs, machinery, etc) – $120k
Obsolescence – $20k
Damage – $10k
Administrative – $90k
Loss (stolen, etc) – $30k
Total – $350k
Divide the inventory costs by the average inventory value.
$350k / $2500k x 100 – 14%
Add up your
The opportunity cost of capital (the return you could reasonably expect if you use the money elsewhere) – 7%
Insurance – 4%
Total – 11%
Add your percentages 14%+11% = 25%
Your inventory carrying rate is 25%, so the cost of holding $2.5million in stock is $625k, which is significantly higher than the initial direct costs associated with inventory. The hidden costs of insurances, opportunity costs, taxes, etc can be quite significant.
When calculating these costs, you should be quite meticulous in going through your general ledger and breaking these costs down and then tracking them, so that you have a very clear idea of what your carry cost actually is.
In our next issue we will look at a few other metrics. Stay posted!!