Inventory management is inherently connected to the success of your ecommerce company. If your inventory management is handled poorly, there’s a good chance you’ll experience product stockouts or have too much capital tied up in your existing SKUs. However, when your inventory management strategy includes inventory analysis, benefits abound.
Not only does inventory analysis help guarantee you have the right amount of inventory available, but it reduces your operational costs and promotes better demand forecasting too. By streamlining your inventory management via inventory analysis metrics, you’ll have a greater understanding of stock counts and your overall operating efficiency, as well.
What is Inventory Analysis?
Inventory analysis is a process for examining inventory levels to determine the ideal amount your company should carry. With careful inventory analysis, you can gain practical insight around the profitability of your inventory, and have an easier time keeping up with fluctuations in customer demand. What’s more, inventory analysis is foundational to increasing sales and controlling costs at the same time. That’s because these calculations identify product trends to help reduce stockouts, boost fulfillment, and improve your supply chain management.
Why You Need An Inventory Analysis Strategy
Conducting routine inventory analysis helps to keep your inventory management on track and can increase efficiencies over time. Some of the greatest benefits to a sound inventory analysis strategy include always having enough stock, accuracy of demand forecasting, less capital tied up in inventory, and a more streamlined supply chain process.
1. Always have enough inventory on hand
An inventory analysis strategy targets a range of product identifiers — in demand, essential, scarce, and so on — that are necessary for keeping the right products (in the right quantities) on your warehouse shelves. Using stock analysis, your ecommerce company can ensure it has just enough inventory items on hand to avoid stockout or overstock situations.
2. Accurately forecast inventory
More often than not, dead stock results from inaccurate inventory forecasting, which is why it’s crucial to have an inventory analysis system in place. A trusted inventory analysis and reporting strategy will collect data on all your SKUs, which ultimately improves both forecasting and reordering accuracy. In addition, these insights can also be used to adjust pricing (and increase revenue).
3. Tie up less capital in inventory
Speaking of cash flow, it’s common for manufacturers and retail businesses to have the bulk of their capital tied up by inventory. Thankfully, with effective inventory analysis, your company can get a good grasp on its lead times (as well as customer demand), so you can better prepare with safety stock or stop buying inventory that doesn’t sell. This translates to less excess or stagnant inventory, which takes up space and incurs greater carrying costs.
4. Streamline your supply chain
Inventory analysis is vital to supply chain optimization since it can help you consolidate suppliers or shift to single sourcing (to reduce overhead and simplify your operations). On top of that, inventory analysis offers visibility into the product life cycle (launch, growth, maturity, etc.), which is paramount to supply chain productivity and keeping stock levels where they need to be.
Common Inventory Analysis Methods
Depending on what kind of business you run (i.e. what types of inventory you carry), you can leverage a few different inventory analysis methods. Today, some of the most well-known and widely-used strategies include ABC, HML, VED, and SDE analysis — all of which serve a designated purpose and have advantages for specific business models.
1. ABC (Value Analysis)
One of the most popular methods for inventory analysis is ABC, or ‘Always Better Control.’ With ABC analysis, retailers can classify their inventory based on each items’ consumption value and impact on annual inventory costs. The ABC approach divides goods into one of three categories:
(1) A-inventory: the most valuable products, with the largest contribution to profits.
(2) B-inventory: ‘interclass’ goods, falling between the most valuable and least valuable products.
(3) C-inventory: account for the small transactions that are vital to collective profit margins, but their average cost doesn’t matter much on an individual level.
ABC analysis allows you to give your most important inventory additional time and focus, thus boosting revenue and helping control your costs. Moreover, utilizing an ABC strategy can reduce dead stock, optimize inventory turnover rate, and assist with demand forecasting.
2. HML (Unit Price Analysis)
HML analysis classifies or measures inventory according to the cost per item (per piece). This type of inventory management analysis also segments products into three categories:
(1) High Cost: high unit value item.
(2) Medium Cost: medium unit value item.
(3) Low Cost: low unit value item. While these items should always be listed in descending order of unit value, it will be up to you to fix limits for these categories as you see fit.
Although HML only considers an item’s unit price — in other words, it doesn’t consider each items sales value — it’s still quite useful for controlling costs and staying on budget.
3. VED (Functional Analysis)
VED analysis is based on inventory value, meaning how important it is for an item to be in stock. The VED approach is often used by manufacturing companies who likely stock a variety of different components and parts. Unlike ABC analysis, VED is only concerned about how necessary an item is to the continuing operation of your business. VED inventory is typically broken down into three categories:
(1) Vital: inventory that must be in stock.
(2) Essential: a minimum amount of these items will suffice.
(3) Desirable: these goods are optional to stock.
With this classification in mind, a VED analysis is done to determine the true necessity of an item and its effect on production and/or other operational services.
4. SDE (Scarcity Analysis)
The SDE inventory analysis method is centered around the scarcity of items in the market, or how soon your company can acquire the goods it needs. In that way, SDE analysis looks at what inventory is available, and classifies each item or SKU according to the scarcity of supply.
With this approach, scarce products are usually imported, which means they may take longer to arrive (or the supply may be harder to come by).
SDE analysis also involves three divisions of inventory:
(1) Scarce: imported items with longer lead times.
(2) Difficult: goods whose lead time ranges from a few weeks to six months.
(3) Easily available: items which are readily acquired. Businesses who utilize the SDE method often deal with raw materials or similar items (with a long lead time prior to acquisition).
Key Inventory Analysis KPIs & Metrics to Track
A detailed, in-depth inventory analysis will use a series of key performance indicators (KPIs) to tell you straight away how your business is doing. Among the most effective (and important) metrics for inventory analysis are inventory turnover ratio, inventory write-offs, gross margin return on investment, days inventory outstanding, and stockout rate.
1. Inventory turnover ratio
Inventory turnover ratio measures how many times a company sold and replaced (i.e. turned over) its inventory during a specific period of time. Inventory turnover can actually affirm the efficiency of your business, seeing as a higher turnover rate is associated with selling a lot of merchandise (without stocking too much inventory). To calculate turnover for yourself, you can use the formula: inventory turnover ratio = [cost of goods sold ÷ average inventory].
2. Inventory write-offs
An inventory write-off gives formal recognition to the portion of your inventory that no longer has value. In general, an inventory write-off is recorded in one of two ways: (1) it’s expensed directly to your cost of goods sold (COGS) account, or (2) it might offset your inventory asset account. Write-offs happen when stock becomes damaged, spoiled, obsolete, or stolen; if inventory only decreases in value — and is not lost completely — it’s often written down instead of written off.
3. Gross Margin Return on Investment (GMROI)
This gross margin return on investment (or GMROI) tells business owners the amount of money they got back for every dollar they spent on inventory. That is to say, GMROI measures your profit return on the funds invested in your stock. To calculate GMROI for your own company, use the formula: GMROI = [gross margin ÷ average inventory cost].
An answer above one means you’re selling goods for more than what you paid for them; likewise, a number below one means you are selling them for less than their cost price.
4. Days Inventory Outstanding (DIO)
Days inventory outstanding (DIO) — sometimes called ‘days in inventory’ — has to do with the average number of days you hold your inventory before selling it. This particular metric reveals how quickly a company can turn inventory, meaning it’s a wonderful indicator of operational and financial efficiency. To find your brand’s unique DIO, you can use the formula: days inventory outstanding = [average inventory ÷ cost of sales] x number of days in period.
5. Stockout rate
Stockout rate is the percentage of items that are unavailable on the requested need date from the buyer. This KPI highlights a company’s inability to deliver products from stock within the advertised (or contractually agreed upon) window due to insufficient inventory. Stockout rate is often used to gauge the effectiveness of inventory replenishment within distribution networks. The stockout formula is: stockout rate = [frequency of stockouts ÷ annual sales volume].
4 Inventory Analytics Tools That Save Time & Money
While there are a variety of inventory management and inventory analysis tools on the market today, only a few have the features and functionality to help them stand out from the rest. Some of the best management platforms for modern, product-based businesses include Extensiv Order Managere, SkuVault, Daasity, Inventory Planner, and Shopify POS (all of which are outlined below).
1. Extensiv Order Manager
Extensiv Order Manager supports businesses in synchronizing their inventory data and analysis across sales channels, warehouses, 3PLs, POS systems, purchase orders, and more. Extensiv Order Manager’s advanced automations for inventory tracking and reporting help minimize storage costs, eliminate dead stock, avoid stockouts, and even balance inventory turnover ratios. Plus, by analyzing real-time data, your company can better schedule sales orders for raw materials, which eliminates stockouts and backorder inventory.
Extensiv also knows inventory forecasting is integral to a healthy inventory management system. That’s why Extensiv Order Manager’s customers receive help with their forecasting efforts, to ensure they have the right products and product quantities available to satisfy demand (without causing a surplus). Lastly, Extensiv can help your company with both safety stock and reorder point setting. When using these components in conjunction with inventory analysis, you can easily avoid overselling and guarantee a positive customer experience with every order.
SkuVault connects all of your channels, organizes your warehouses, and manages your inventory with powerful integrations and simple workflows. With the SkuVault system, your company can access vital inventory data and analytics to construct detailed reports and make sure you never oversell (or run out of any product). When SkuVault and Extensiv work together, ecommerce companies can enjoy a high-quality inventory control system that correctly fulfills customer orders and identifies any potential errors within the order fulfillment process.
Daasity’s software is recognized for its inventory data analytics that have been designed for non-technical users — meaning they’re easy to understand and translate into real results. With Daasity, your online store will feel empowered to move beyond basic reporting, and instead utilize holistic sales data (broken down into individual channels). When Daasity teams up with Extensiv Order Manager, your company can gather all its analytics into one complete and comprehensive view, so you can unlock useful insights to drive strategic, sustainable, and profitable growth.
4. Inventory Planner
Inventory Planner is a leader in inventory control and demand forecasting, and is equipped with automatic replenishment recommendations to simplify the reordering process. This platform is great for tackling forecasting challenges, since merchants can utilize current data from inventory analysis (based on their sales trends and vendor lead times). Using Inventory Planner in tandem with Extensiv can help your company send purchase orders directly to suppliers, keep track of outstanding orders and arrival dates, and display all your inventory needs in one place.
5. Shopify POS
Shopify POS helps existing Shopify users generate POs and transfer stock based on inventory forecasts and previous performance. Companies can use this software to track incoming and outgoing inventory, transfer goods between locations, and (on certain plans) conduct ABC inventory analysis to distinguish high-priority items. In addition, ecommerce retailers can implement the Extensiv + Shopify integration to optimize their online stores; this merger allows you to manage inventory data from your Shopify account and sync everything in one system.
Still have a few lingering questions about inventory analysis and why it’s important to the success of your business? Read on for answers to the most frequently asked questions related to inventory analysis and its many advantages for ecommerce merchants.