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Inventory Analysis - Everything You Need to Know in 2024

2.5 minutes

This article provides insights on inventory analysis and techniques for conducting an effective inventory analysis in order to optimize inventory management and improve business operations.

inventory analysis
Source: cashflowinventory.com

What Is Inventory Analysis?

Inventory analysis is the systematic process of evaluating a company's stock of goods and materials. This analysis is instrumental in making informed decisions about procurement, production, and sales strategies.

Why Is It Important?

Inventory analysis is important for a business for a number of reasons. We have listed some of the most common reasons below:

Efficient Resource Allocation: Inventory analysis ensures resources are allocated where they're needed most, preventing overinvestment in less valuable items and focusing on high-demand products.

Minimized Costs: It helps minimize costs associated with carrying excess inventory, storage, and potential stockouts, improving overall cost-effectiveness.

Customer Satisfaction: By maintaining the right inventory levels, businesses can consistently meet customer demand, leading to increased customer satisfaction and loyalty.

Optimized Profitability: Effective inventory analysis directly impacts profitability by reducing waste, enhancing cash flow, and maximizing the return on inventory investments.

Strategic Decision-Making: It provides the data needed for informed decisions regarding procurement, production, and sales, allowing businesses to adapt quickly to market changes and opportunities.

Competitive Advantage: Proper inventory management can provide a competitive advantage by ensuring products are readily available, meeting customer expectations, and reducing operational costs.

Key Inventory Analysis Metrics

Understanding the key metrics for inventory analysis is crucial for maintaining efficient inventory control. We highlight some of these below: 

Inventory Turnover Ratio

Formula: Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory.

This metric gauges inventory efficiency by showing how many times inventory is sold and replaced within a year. A higher ratio indicates efficient management.

Days Sales of Inventory (DSI)

Formula: DSI = (Average Inventory / Cost of Goods Sold) x Number of Days in the Period.

DSI reveals the number of days it takes for a company to sell its entire inventory. It provides insights into inventory liquidity. A shorter DSI suggests that inventory is moving quickly, while a longer DSI may indicate slow-moving or obsolete stock.

Gross Margin Return on Investment (GMROI)

Formula: GMROI = (Gross Margin / Average Inventory Cost) x 100.

GMROI assesses the profitability of inventory. It measures how much profit is generated per dollar invested in inventory. A higher GMROI indicates better profitability, meaning the company is effectively turning inventory into profit.

ABC Analysis

ABC Analysis is a classification method categorizing inventory into three categories: “A,” “B,” and “C,” based on their importance or value. ABC Analysis helps prioritize inventory management efforts, focusing resources where they matter most.

Lead Time

Lead Time represents the time it takes for an order to be fulfilled; from the moment it's placed to when the inventory arrives. Reducing lead times is crucial as it minimizes the need for excessive safety stock. 

Stockout Rate

Stockout Rate measures how frequently a business experiences situations where it runs out of stock and can't fulfill customer orders. Monitoring and reducing the stockout rate are vital for maintaining customer satisfaction and revenue consistency.

what is inventory analysis
Source: deskera.com

Framework for Effective Inventory Analysis

Good inventory analysis ensures the right balance between product availability and cost control for long-term success. Here's a simple, step-by-step framework to help you optimize your business operations:

Step 1: Demand Forecasting

Accurate predictions of future demand are essential. Businesses use historical data, market trends, and advanced models to anticipate demand, avoiding stockouts and overstock.

Step 2: Safety Stock Management

Optimal safety stock levels are crucial. Analyzing demand variability and lead times balances product availability with minimizing excess inventory.

Step 3: Supplier Evaluation

Assessing supplier reliability and performance is key. Beyond costs, factors like on-time deliveries and quality matter. Strong supplier relationships reduce supply chain risks.

Step 4: ABC Analysis Implementation

Prioritizing inventory with ABC classification improves resource allocation. Items classified as "A" get more attention, "C" items less. This streamlines inventory management.

Step 5: Inventory Cost Control

Minimizing carrying costs is vital. Strategies include evaluating storage, negotiating insurance terms, and monitoring obsolescence. Cost control enhances profitability and efficiency.

how to do inventory analysis
Source: freshbooks.com

Example: Fresh Harvest

To illustrate our framework better, let's use an example. Consider Fresh Harvest, an online retailer specializing in organic groceries. They offer a wide range of products. They offer fruits and vegetables with an average monthly demand of 2,000 units, organic milk with an average monthly demand of 5,000 units, and specialty spices with an average monthly demand of 500 units.

They implement our inventory analysis framework below:

Step 1: Demand Forecasting

Fresh Harvest relies on historical sales data, seasonal patterns, and market trends to predict demand. For instance, they anticipate a surge in orders for organic fruits and vegetables during the summer, reaching up to 5,000 units per month.

Step 2: Safety Stock Management

To safeguard against stockouts, especially for high-demand items like organic milk, Fresh Harvest maintains safety stock equivalent to one month's demand, or 5,000 units, ensuring uninterrupted product availability, even during peak seasons or unforeseen supply chain disruptions.

Step 3: Supplier Evaluation

Beyond price considerations, Fresh Harvest evaluates suppliers based on reliability, product quality, and responsiveness. This approach ensures a steady supply of high-quality organic products, even in challenging circumstances.

Step 4: ABC Analysis

Fresh Harvest categorizes products using ABC classification. High-value and frequently purchased items like organic milk receive close monitoring, while lower-value or slower-moving items like specialty spices, with monthly sales of 500 units, require less attention.

Step 5: Cost Control 

Fresh Harvest actively manages carrying costs by optimizing storage space, negotiating favorable insurance terms, and monitoring inventory for potential spoilage or expiration. These measures minimize waste and enhance profitability.

By applying this framework, Fresh Harvest optimizes its online organic grocery retail operations. They ensure product availability, reduce costs, and enhance customer satisfaction in the competitive organic food industry.

We hope this article has given you a better understanding of what inventory analysis is and how to use it effectively.

If you enjoyed this article, you might also like our article on what type of account inventory is or our article on MRO inventory.

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