5 Key Inventory Management KPIs Every Food Business Should Track

What is Inventory Management?

No business can streamline its operations without a comprehensive understanding of what products are being used, how much is being used, which ingredients have run out and must be reordered, which items generate the most demand, which items sit idle on the shelves as dead stock, and which items get wasted. This calls for meticulous inventory management.

Inventory management entails the ordering, maintenance, use, and sale of supplies by businesses. It involves methods used for storing, processing, and handling both raw materials and finished products.

In this regard, inventory management is closely connected with supply chain management, and for restaurants, this involves the management of products as they move from the farm to the fork, passing through warehouses, food processing units, and retail outlets in between. With the help of inventory management systems, businesses can keep an accurate record of stocks as they move into and out of warehousing facilities and restaurant points of sale.

Automated software, in this regard, makes the job of inventory management less tedious and more accurate. There's a range of inventory management software to choose from, but care should be taken to select one that ensures the right ingredients are delivered in the right amounts at exactly the right time.

The most vital objective restaurants can meet by managing inventory is ensuring that supply shortages are identified early, and there are always enough supplies to meet demand and keep consumers happy. Customer satisfaction assumes even more importance when the ingredients in question go into making a highly popular product. Inventory management also ensures that the organization doesn't waste money holding unusable stock. For a restaurant, oversupply as a result of faulty inventory management adds to food wastage (which is already high) and increases food costs.

Why is it Important to Measure Inventory Management KPIs?

It is not enough to merely manage inventory. To be successful, a business also needs to regularly monitor how its inventory management activities are panning out. This can be done with the help of inventory management key performance indicators (KPIs).

Performance measured against these inventory metrics provides actionable insights into the business, and this shapes decision-making. With decisions being strictly data-driven, a business is able to prevent undersupply that hampers sales opportunities, and avoid oversupply resulting from over purchase and plummeting demand, which results in resource wastage. Both under- and oversupply clog the cash flow of the organization. It can, however, be prevented through inventory management backed by sound KPIs.

Some of the inventory metrics to consider are average inventory, sale-through rate, weeks of supply, inventory turnover rate, inventory carrying costs, sales ratio, order cycle time, lead time, inventory accuracy, perfect order rate, the accuracy of demand forecasts, and inventory shrinkage. These KPIs give businesses a good idea of what to buy and hold, and in what quantity.

Operational and employee efficiencies can also be enhanced by applying KPIs to gauge the success of inventory and supply chain management. Revenue can be boosted too. Insights gleaned from an analysis of the organization's inventory management performance will reveal areas that are costing the company most, so that strategies can be drawn to reduce operating costs.

It will be unwieldy to describe and discuss all the KPIs in one article. So let's look at five critical inventory metrics.

5 Key Inventory KPIs- Stock-to-sales Ratio and How to Measure it

This inventory KPI measures the value of the inventory available for sale vis-a-vis the value of the inventory that has already been sold. It can be calculated using the following formula-

Stock-to-sales ratio = Value of inventory available/value of sales

The stock-to-sales ratio assists organizations in optimizing their inventory levels. Ideally the amount of inventory available should be comfortably more than what is being sold. This prevents stockouts and the resultant loss of face before the customer, and eventual loss of revenue. This KPI is vital for establishing inventory control.

One way for organizations to skirt around the problem of stockouts is to sell on backorder instead of letting sales opportunities go a-begging.

The stocks to sales ratios shouldn't, however, be too high, as that would mean stocks lying unused and unsold. This would increase inventory carrying costs, and lead to resource wastage.

Inventory Turnover and How to Measure it

Inventory turnover rate measures product sales frequency over a period of time and is used to assess the effectiveness of inventory management systems.

The following formula is used to compute the inventory turnover ratio-

Inventory turnover ratio = cost of goods sold (COGS)/average inventory value

Alternatively, it can be calculated thus-

Inventory turnover ratio = sales/average inventory

In this context, the average inventory value is derived by adding the values of starting and ending inventory levels and then taking an average.

Low inventory points to poor sales and accumulating stocks. This spells poor Restaurant Economics. A higher turnover ratio, on the other hand, indicates robust sales, attractive discounts/loyalty programs, and heightened efficiency.

In order to push inventory turnover rates up, a company may reduce stock levels in the warehouse, but this does not pay in the long run as it won't allow the company to fulfill customer orders effectively.

Gross Margin Return on Investment and How to Measure it

This metric measures gross margin per inventory cost. Gross margin, in this regard, refers to net sales value minus the cost of goods sold. It is, therefore, the money retained by an organization after incurring direct expenses related to the production of goods and services. Put simply, gross margin may also be termed as gross profit margin, which is essentially calculated by dividing gross profit by net sales.

Gross margin return on investment (GMROI) gauges the effectiveness of inventory to produce cash flows and profits. It essentially gives you an idea of how diligently your inventory is working to earn profits for you.

GMROI is one of the most important inventory KPIs and allows businesses to safeguard their cash flows. This is a vital function for organizations because while they can still make do without profits, cash flows drying up would mean disaster.
The gross margin return on investment can be calculated in the following way-

GMROI = Gross margin/average inventory cost

A high GMROI may be produced both, by stocks that turn at a gradual rate but generate high margins, and by stocks that turn quickly but generate low margins, according to retail specialist Paul Erickson. A low GMROI, on the other hand, points to a slow-moving or low-margin product.

GMROI is measured usually on a yearly basis, and organizations should aim to increase it year after year.

Sell-through Rate and How to Measure it

This refers to the percentage of the stocks sold over a particular period of time. It shows the speed at which your inventory is moving. Therefore, if the sale-through rate is 100%, it means that you have sold your entire inventory. At the other extreme, a 0% sale-through rate indicates that you have not sold anything at all. This inventory KPI can be calculated thus-

Sale through rate- Inventory sold/ (Inventory sold + inventory on hand)

Sell through rate, therefore, is a measure of the proportion of the inventory available with an organization that could actually be sold. A low sale-through rate means that you are overstocked, incurring unduly high inventory carrying costs, and running the risk of food wastage. It may also mean that your products are too costly, scaring away potential buyers. On the other hand, if this metric is too high, it would point to a plunge in the organization's inventory levels. It may also mean that products are being offered at throwaway prices.

Most retailers aim for a sale-through rate of 80% by the time they start their markdowns (cutting the original price of goods to boost sales), retail pundit Karim Kanji says.

Weeks of Supply (WOS) and How to Measure it

This KPI looks at stock levels in the backdrop of time, and measures how long an organization would have inventory on hand if products keep on selling at the current pace.

It can be computed thus-

Total inventory on hand/average weekly product sales

Weeks of supply is a metric that helps organizations monitor inventory levels, and aids in inventory planning so that the shelves are kept well-stocked at all times. Like some of the other inventory KPIs mentioned earlier, weeks of supply, when carefully considered, ensures that strict inventory control can be exercised and stockouts don't happen. This is important to protect the flow of revenue and keep customers satisfied. According to a Harvard study, almost half of all intended purchases were lost by retailers since the product that the customers were seeking was not available.

The sweet spot for most retailers, as far as weeks of supply is concerned, is 10-12 weeks. This gives businesses a good enough buffer to ensure that there is always enough inventory to take care of customer demand.

Inventory management solutions can help organizations perform well on this metric by allowing automated alerts when the weeks of supply goes below a particular threshold. The point of sale (POS) system can also be calibrated to notify business owners when inventory on hand depletes.

Advantage of a Good Inventory Management System

1. Real-time monitoring-
Restaurants would never want to be caught in a situation where they are unable to serve customers their favorite dishes due to a supply shortfall. Restaurant Inventory management seeks to prevent such embarrassment. Inventory management systems help in monitoring inventory levels in real time so that business owners can be notified before stocks run out. Software, in this regard, can be trained to work around a reorder point. Automated restaurant inventory management solutions can generate purchase orders when stock levels approach the reorder point.

2. Reduced food costs and wastage-
The expenditure on food has to be limited to 35% of the revenue so that Restaurant Operations are viable. However, there are often undue additions to food costs on account of food wastage. Food wastage is a particularly worrying problem in the US, and restaurants in the country are known to throw away nearly 30 billion pounds of food every year. This not only has a deleterious humanitarian effect but also wreaks havoc on a restaurant's finances. The restaurant is forced to spend money on, and dedicate storage space to, products that sell very slowly, or not at all, and simply spoil sitting on shelves. Such dead stock may be created by a poor prediction of demand and overbuying. Efficient inventory management, supply chain management, and demand/sales forecasting solutions can, however, keep supply in sync with expected demand. Technology can also help to match actual and projected resource utilization.

3. Better supplier management-
When bargaining with suppliers, restaurant owners who use efficient inventory management systems will have an edge over those who don't. A sound inventory management strategy lets businesses balance supply and demand. A restaurant using sophisticated inventory management tools can ensure that fresh ingredients are always available. As discussed earlier, an automated inventory management system can place orders and keep restaurants well-stocked without restaurant employees having to lose sleep over depleting stocks. Technology also helps restaurants identify suppliers who fulfill orders on time, and who can, therefore, be relied upon.

4. Data-driven strategies-
Inventory management software offers crucial sales information and helps businesses comprehend their demand-supply dynamics better. Sales data helps in identifying best-selling menu items and those that don't have many takers. Sales data also allows organizations to forecast demand accurately with an eye on inventory optimization, taking into account future events. The discovery of the inventory turnover ratio opens up the possibility of lowering the carrying costs of inventory.