Chapter #4

Inventory Analysis: Definition, Tips, Methods, KPIs, and Tools in Malaysia

In this chapter, we will look at the inventory analysis process and give you some of the best inventory analysis methods, KPIs, and best practices in order to improve your inventory management to determine the right amount of stock to keep on hand to fill demand while avoiding risk associate with it.

inventory analysis

What is Inventory Analysis?

Inventory analysis is a process to determine the optimal inventory level for a business by looking at the customer/production demand to minimize the amount of stock on hand to avoid overstocking and avoid inventory going out of stock and losing a customer to a competitor.

Traditionally it has been done by balancing the costs of ordering and holding inventory (known as the economic order quantity). However, that does not provide the full picture and more inventory analysis is required to account for additional factors that can bring challenges to your supply chain and inventory management.

Why is Inventory Analysis Important?

Inventory analysis is important because it helps you to optimize your inventory, improve inventory purchasing decisions, better manage cash flow and significantly reduce in lost sales. This is because with inventory analysis you will have a better prediction of what products are going to sell and how much, giving you the advantage of better inventory planning.

Furthermore, it helps you to reduce the working capital needed for inventory investment as you will improve your purchasing by reducing investment for low turnover inventory.

With less cash being tied up to low-selling inventory, you will be able to focus more on fast-selling stock and ensure you are not running out of stock which results in a better customer experience and an increase in revenue.

Lastly, all this comes to a reduction of obsolete inventory and high inventory handling costs since low-selling items are being kept at minimal levels to ensure minimal or no wastages in your inventory. It also helps you to better track your inventory and avoid any theft or losses as well as accidents.

Benefits of Inventory Analysis

Here are some of the biggest benefits of inventory analysis:

  • Establishing a proper warehouse layout.
  • Reducing lead time in acquiring raw materials and sellable items.
  • Implementing proper authorization.
  • Correct item classification for better cost management.
  • Adequate management of dormant inventory items.
  • Improving utilization of the company’s capital.
  • Improving cash flow and profit margins.
  • Future identification of possible opportunities or losses.

Best Inventory Analysis Method

Different methods are being used in order to correctly conduct inventory analysis. Here are five best inventory analysis methods:

1. SDE Analysis

SDE analysis helps you to optimize your supply chain and procurement processes in order to better meet customer demand and optimize your inventory planning. This process will help you better plan your year ahead with procurement.

This analysis is especially useful in the markets where certain items are more limited so businesses can better plan their inventory policies.

SDE analysis classifies inventory into three different levels based on the availability of items or materials in the market:

  • (S) Scarce: Refers to generally imported items that require longer lead times and often are in short supply. For example, imports of goods are subject to government stringent regulations and ultimately slow down the procurement process.
  • (D) Difficult: Refers to items that are often available domestically but are difficult items to procure. For example, items that generally come from far cities or where reliable suppliers are difficult to find. The general rule of thumb for this classification is if the inventory stock requires more than a fortnight to be available, but less than six months lead time it should be classed as difficult.
  • (E) Easy: Refers to freely available items, that are often procured quickly and locally, relatively hassle-free.

Although using this type of analysis can help make a foggy inventory picture clearer, it isn’t always very accurate. It can help loosely with planning, but one difficult product might vary drastically from another difficult product.

2. HML Analysis

HML analysis is a tool used in inventory management to help classify inventory items and inventory control.

HML analysis is an inventory method that categorizes inventory based on a product’s unit price. This method classifies inventory into the following categories:

  • (H) High Cost: Includes high unit value/cost products. Normally they are 10-15% of the total items.
  • (M) Medium Cost: Includes average or medium unit value items. 20-25% of products fall into this category.
  • (L) Low Cost: Includes items with low unit value. 60-70% of the products are usually low-cost.

Under this system, items are classified according to how fast they move or turnover.

3. ABC Analysis

abc analysis important part of inventory analysis process

ABC inventory analysis is a technique that determines the value of inventory items based on their importance to the business by classifying them into three groups (A, B, and C) in order to help inventory managers and business leaders to understand which products or services are the most critical to the financial success of the organization.

This technique is based on the Pareto rule of 80/20 as ABC analysis identifies the top 20% of inventory items that deliver about 80% of the value.

4. VED Analysis

VED Analysis helps you to classify items based on the critical value and shortage cost of items caused by going out of stock. The items are classified into three categories:

  • (V) Vital Items: These are inventory items that are necessary for production or other processes and the cost of stocking out would be disastrous. For example, for car manufacturing, tires are vital items and without that, it would stop the entire production.
  • (E) Essential Items: These are inventory items whose stock-out cost would be very high. While these won’t shut your shop or production, customers expect these items are always in stock whether it is a retail store or manufacturing business. For example, if the same manufacturing company was missing spare parts for fixing any broken car it would negatively affect company sales and even customer experience.
  • (D) Desirable Items: These are inventory items good to have in order to increase sales however they do not affect your business at large. In case you are out of stock of the items, it won’t negatively affect your sales or customer service. For example, if the automobile manufacturing company was missing a dashcam or other car accessories that customers like to purchase with a car.

5. FSN Analysis

FSN analysis categorizes inventory into three different categories based on how fast a company sells or used its items:

  • (F) Fast-moving inventory: The inventory turnover ratio of fast-moving goods is more than 3 and accounts for approximately 10%-15% of the total inventory.
  • (S) Slow-moving inventory: Slow-moving goods often have an ITR of 1-3 and account for 30%-35% of the total stock.
  • (N) Non-moving inventory: ITR of non-moving goods is below 1 and amounts to 60%-65% of the total inventory.

If you want to segregate the inventory and figure out the demand or movement of products, this is one of the best techniques

Key Inventory Analysis Metrics (KPIs)

What can be measured, can be improved, and if you want to improve the way how you operate your inventory management it’s important to measure key inventory analysis metrics/KPIs. With that here are the top eight inventory analysis metrics:

1. Inventory Turnover Ratio

The Inventory Turnover Ratio is a financial formula to measure how quickly your inventory is sold and replaced during a given period. The ratio considers the cost of inventory sold relative to its average inventory for a year in any set period of time.

This ratio is important because it can indicate that some items may be turning over quite rapidly whereas others might have failed to sell at all. The ratio is also useful when compared to the previous year’s ratio as well as the competitor’s ratio in order to analyze any trends, and business performance and it gives an idea of how efficiently your company is managing its inventory.

inventory turnover ratio formula for inventory analysis

2. Average Inventory

Average Inventory is a calculation to estimate an amount or value of inventory a business has over a specific period of time. This is to balance large spikes in inventories during high seasons, large shipments received, or sudden buying surges. Usually, this is done at the beginning and end of the accounting period.

The average inventory formula helps business managers understand the inventory the business needs to hold during its daily course of operations to manage inventory more cost-effectively to optimize its profit.

It is one of the simplest formulas to conduct inventory analysis and with a simple spreadsheet, it can be easily done.

average inventory formula for inventory analysis

3. Sell Through Rate

The Sell Through Rate formula measures the amount of inventory you’ve sold in a month versus the amount of inventory shipped to you from a manufacturer. In other words, it measures the number of products sold in a month compared to the total inventory at the beginning of the month.

The Sell-through rate is an important retail sales metric that allows you to monitor the efficiency of your supply chain.

Any product that is on your shelf is costing you money and your goal should be to sell it as fast as possible. With the sell-through rate formula, you’ll find out that there is something wrong with your item and dive deeper to analyze why your inventory is selling slowly. Therefore, as a leading indicator, the sell-through rate won’t tell you what’s wrong but rather that something is wrong.

4. Inventory Write-Offs

Inventory write-off simply means removing a value from a part of your inventory due to loss, theft, damage, deterioration, misplacement, etc. This is to acknowledge that the inventory is no longer to be sold for profit, but it became an expense for a company.

Because, when inventory is purchased, it’s seen as an asset for a company as it is intended to be sold for profit, however for any reason the inventory can no longer be sold for profit, the company can use the write-off process for tax purposes as it will no longer be an asset but an expense.

Inventory write-offs are done to support accounting accuracy objectives while also reducing the tax liability for business owners.

5. Gross Margin Return on Investment (GMROI)

Gross margin return on investment is an inventory profitability evaluation ratio that helps businesses to see how well they are able to turn inventory cost into inventory profit. It demonstrates whether a retailer can make a profit on their inventory.

It is calculated by dividing the gross margin by the average inventory cost and is used often in the retail industry.

gmroi or Gross Margin Return on Investment formula for inventory analysis

6. Days Inventory Outstanding (DIO)

Days inventory outstanding (DIO) is the average number of days that a company holds its inventory before selling it. The day’s inventory outstanding calculation shows how quickly a company can turn inventory into cash. It is a liquidity metric and also an indicator of a company’s operational and financial efficiency.

Days inventory outstanding is one component of the cash conversion cycle (CCC), together with days payable outstanding (DPO) and days sales outstanding (DSO). The CCC measures how quickly a company converts its investment in inventory into cash

7. Stockout Rate

The Stockout rate is the percentage of items not available when needed for sale. It is calculated as items, not in stock divided by the total available items in inventory. The average stockout rate is about 8%, and it rises when products are on sale. A high stockout rate can lead to significant lost sales.

8. Back Order Rate

The Back Order Rate KPI measures how many orders cannot be filled at the time a customer places them. A high back order rate means your customers are forced to wait while you attempt to fill their order, which will adversely affect customer satisfaction and retention in the long term.

This supply chain KPI is closely related to the inventory accuracy KPI and percentage of out-of-stock items KPI. Monitor this KPI to identify why certain items are not in stock and to deal with trends (such as seasonal demand) that may affect your performance.

How Do You Analyze Inventory?

In order to properly conduct inventory analysis, it’s important to implement inventory analysis methods mentioned above as well as to track important inventory KPIs. Besides that, it’s also important to implement relevant inventory management techniques and best practices in order to effectively optimize your inventory based on your inventory analysis.

How Does Inventory Management System Help with Inventory Analysis?

An inventory management system helps you collect data from multiple sources, whether from your barcode scanner, eCommerce, warehouse, or manually from your employees. It provides real-time inventory analysis based on collected data and historical data in order to improve your inventory forecasting and purchasing.

An inventory management system optimizes inventory levels and ensures product availability across multiple channels. It provides a single, real-time view of items, inventory, and orders across all locations and selling channels.

It keeps track of changes to inventory at all three stages and adjusts asset values and costs accordingly and improves your overall inventory process efficiencies in order fulfillment, purchasing, handling, stock levels, customer request, and more.

Dynamics 365 Business Central with Shopify Integration

The Shopify connector gives customers the ability to connect their Shopify store (or stores) with Business Central in order to maximize business productivity. By using the Shopify connector, they can manage and view insights from their business and their Shopify online store as one unit.

Microsoft Dynamics 365 Business Central is teaming up with Shopify to help our customers create a better shopping experience. While Shopify provides merchants with an easy-to-use e-commerce solution, Dynamics 365 Business Central offers comprehensive business management across finance, sales, service, and operations teams within a single application. Seamless connection between the two systems will synchronize orders, stock, and customer information to ensure merchants can fulfill orders faster and better serve customers.

This can result in:

  • Agile processes: Connecting Dynamics 365 Business Central with Shopify will help merchants all over the world implement more agile online business processes while keeping people focused on selling.
  • Rapid response: With connected data from across online stores and business operations, merchants can rapidly respond to consumer demands to adjust product pricing and merchandising.
  • Multiple scenarios: With support for multi-tier pricing structures and multiple currencies, companies, and entities, Dynamics 365 Business Central will support multiple Shopify store scenarios with ease.
  • Improved visibility: By connecting Shopify and Dynamics 365 Business Central, merchants will improve visibility into stock, pricing, existing customers and order history, order status, billing,

and payments. Better visibility means faster customer inquiry responses, timely returns and refunds, and more accurate order processing.

Try Dynamics 365 Business Central as Your ERP Inventory Management System

deliver exceptional customer experiences using warehouse management solution malaysia

Dynamics 365 Business Central is an all-in-one ERP Business Management solution that automatically pulls systems and processes together to manage financials, sales, service, and operations. It includes an inventory & warehouse module that enables you to unify your views across warehouse and inventory to increase visibility, optimize stock levels with AI predictions, minimize costs of operations, and increase productivity and customer experiences.

Contact us to learn more about Dynamics 365 applications and how they can help you better manage your inventory management. Learn more about ERP Inventory management.

Learn more about Microsoft Dynamics 365 Inventory Management Applications

Dynamics 365 is a portfolio of business applications that meets organizations where they are—and invites them to digitally transform. Each app is designed to remove the barriers and eliminate silos within organizations by working together with existing systems—or the entire portfolio of Dynamics 365 apps—for outcomes you simply can’t get unless every part of the business is connected seamlessly. Dynamics  365 offers several options for an inventory management system, each to fit your needs. Contact us to get personalized suggestion based on your needs, budget and industry.

Microsoft Dynamics 365 Business Central- inventory management solution

Dynamics 365 Business Central is an all-in-one enterprise resource management System for Small-Medium Size Businesses to centralize, simplify and automate your business processes across Finance, Supply Chain, Sales, Inventory & Warehouse Customer Service, Manufacturing, and Projects.

Microsoft Dynamics 365 Supply Chain Management - inventory management system

Dynamics 365 Supply Chain Management transforms your manufacturing and distribution operations and predicts disruptions and responds fast by digitizing your supply chain, warehouse and inventory management, enhancing visibility, improving planning, and maximizing asset productivity.

Dynamics 365 Intelligent Order Management logo

Intelligently orchestrate fulfillment, automate with a rules-based system using real-time inventory data, AI, and machine learning. Adapt quickly to future order volumes, complexities with pre-built connectors to specialized technology partners for order intake, delivery and logistics services.

Microsoft Dynamics 365 Commerce - Inventory Management System

Is Customer Automation and Customer Management system. Differentiate your brand by taking advantage of built-in intelligence to deliver faster, more personalized service and add value to every customer interaction.

Microsoft Dynamics 365 Field Service

Provides complete field Service Management including service agreements, predictive maintenance, preventative maintenance, work order management, resource management, product inventory, scheduling and dispatch, mobility, collaboration, customer billing, and analytics.

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