Inventory management affects profitability in more ways than the purchase price of stock. Excess inventory ties up cash and creates carrying, storage, damage and obsolescence costs. Too little inventory can create stockouts, lost sales, production disruption and expensive emergency replenishment. The objective is therefore not to minimize inventory, but to hold the right inventory in the right quantity at the right location.
How Inventory Affects Profit
- Working capital: cash invested in inventory cannot be used elsewhere.
- Carrying cost: storage, insurance, capital cost, handling and shrinkage.
- Obsolescence: slow-moving or expired stock may require markdown or write-off.
- Service: insufficient stock can reduce fill rate and customer retention.
- Operational continuity: missing critical materials can stop production or service.
Core Inventory KPIs
| KPI | Basic formula | What it shows |
|---|---|---|
| Inventory Turnover | COGS ÷ Average Inventory | How quickly inventory is consumed or sold |
| Days Inventory on Hand | 365 ÷ Inventory Turnover | Approximate days of stock held |
| Fill Rate | Demand fulfilled immediately ÷ Total demand | Ability to satisfy demand from stock |
| Stockout Rate | Stockout events ÷ Demand opportunities | Frequency of inventory unavailability |
| Obsolete / Slow Stock % | Value of obsolete or slow stock ÷ Total inventory value | Capital tied up in low-productivity stock |
| Inventory Accuracy | Accurate counted records ÷ Records checked | Reliability of system inventory |
Worked Turnover Example
Suppose annual cost of goods sold is BHD 600,000 and average inventory is BHD 150,000.
Inventory turnover = 600,000 ÷ 150,000 = 4 turns per year
Days inventory on hand ≈ 365 ÷ 4 = 91 days
The result is neither automatically good nor bad. It must be compared with the product’s lead time, demand variability, service target, shelf life and business model.
Why Higher Inventory Turns Are Not Always Better
A very high turnover rate can indicate efficient inventory use, but it can also reflect insufficient stock. If higher turns are accompanied by falling fill rate, increased expedites or frequent stockouts, the business may be cutting inventory too aggressively.
Practical Improvement Levers
- Improve demand and supply planning.
- Set reorder points and safety stock according to lead-time and demand variability.
- Segment inventory with ABC, FSN and VED/VEN rather than using one policy for every SKU.
- Reduce supplier and internal lead times.
- Review slow-moving and non-moving inventory regularly.
- Improve record accuracy through cycle counting and transaction discipline.
- Use supplier agreements such as VMI or consignment where commercially appropriate.
Related SCMANA Guides
Interview Question
Question: If management asks you to reduce inventory by 20%, what would you check before cutting stock?
Answer: I would segment the stock, review service levels, lead times, demand variability, criticality, slow/non-moving inventory and existing safety-stock logic. The first reduction should normally come from excess and obsolete stock or process causes, not from indiscriminate cuts to critical or volatile items.
Download the Practical Workbook
Use the SCMANA Inventory KPI Calculator to calculate turnover, days on hand, service-level and other practical inventory KPIs.
