Key Elements for Managing Inventory Properly: The Basics

Key Elements for Managing Inventory Properly: The Basics

Key Elements for Managing Inventory Properly: The Basics

Peter Drucker, one of the world’s most recognized management gurus, once stated that if something could not be measured, that something could not be managed. Inventory and inventory control falls within these parameters. Inventory management is a key component to running a successful and profitable retail establishment. Procurement and replenishment will be the basis for rotating product and generating a profit. Mistakes in such procedures may diminish the store’s capability to generate profit, may lead to low customer service levels, and may impact the efficiency and productivity of the store. Therefore, a storeowner should plan and measure inventory needs constantly and consistently, making necessary adjustments as the store rotates product.

However, before store owners can measure and manage, they must also understand the basic concepts that make up the topic. The following figures are generally derived from point of sale data or calculated by the point of sale system itself.

Cost of Goods Sold (COGS):

This figure provides the cost associated with selling an inventory item. COGS are the costs of a sale and include merchandise costs, shrinkage, and price. The formula is as follows:

COGS=(Beginning Inventory+Purchases)/(Ending Inventory)

Beginning Inventory and Ending Inventory are inventory values in monetary terms.

Gross Margin:

This value provides the percentage of profit generated from the sale of inventory after accounting for costs of goods sold. The formula is as follows:

Gross Margin=(Sales-COGS)/Sales


GMROII (Gross Margin Return on Inventory Investment) stands for gross margin return on inventory investment and is probably the most important figure in inventory management. GMROII suggests whether sufficient gross margin is being earned from the sale of specific products when compared to the investment required to generate a gross margin. The figure accounts for profitability in merchandise and productivity of the product itself. GMROII is a great way to measure efficiency and it is a ratio of sales, gross margin, and inventory turn. The formula is as follows:

GMROII=(Sales-COGS)/(Average Inventory)

Inventory Turns:

This is another key indicator for organizations that manage inventory and the figure reflects the number of times a business is able to sell and replenish products during a given period of time. The formula is as follows:

Inventory Turns=COGS/(Average Inventory)

Average Inventory:

Average inventory is the quantity of product that is held on average over a specific period. Although the time portion of the figure is generally used as a quarterly period, monthly intervals may also be used. The formula is as follows:

Average Inventory=(Q1+Q2+Q3+Q4)/4

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