2 Key Inventory Metrics Your Logistics Company Should Be Measuring
Average Days on Hand (ADOH)
ADOH represents how much inventory a process has stored expressed in terms of how many days that process could sustain activity by consuming the stored inventory. For example, if a production line has enough of one part on hand to supply the line for 30 production days, then the production line’s ADOH for that part is 30 days.
ADOH is an appropriate measure of lead time your logistics company should use because replenishment is based on consumption, and eliminating the time between consumption and replenishment reduces waiting and increases velocity. Because it is unrealistic to remove all inventory, the goal is to reduce ADOH to minimum levels while sustaining stability of the processes within the supply chain.
Most logistics companies measure inventory using inventory turns. So why do we advocate looking at inventory levels in terms of ADOH? Because doing this enables managers to visualize how much inventory they have relative to one day’s activity. For example, if a supplied item has an order-to-delivery lead time of four days, but 20 days are on hand, it’s easy to see that there is five times as much inventory as needed.
In addition, many logistics companies combine raw materials, work-in-process, and finished-goods inventories to calculate overall inventory turns. Our experience is that this does not provide a meaningful picture of inventory velocity for the processes associated with the different types of inventory. We suggest you evaluate raw material and finished-goods inventories independently.
Use the following formulas to calculate inbound, raw-materials inventory (RMI) and outbound, finished-goods inventory (FGI) in terms of ADOH:
RMI ADOH = Average RMI in dollars / average daily usage in dollars
FGI ADOH = Average FGI in dollars / average daily cost of goods sold in dollars.
Example: Total annual purchases of all inbound material equals $150 million at a company that operates 250 days per year. According to financial statements, average RMI is $60 million. For this company, the RMI ADOH calculation would look like this:
Average daily usage of material = $150 million / 250 days = $600,000 per day
$60 million / $600,000 = 100 days of inventory or 100 RMI ADOH
Inventory Carrying Cost
It’s important for a logistics company to measure inventory carrying cost because excess inventory – holding more than is needed to meet the rate of consumption of the next process – ties up cash and hides process problems. Knowing the carrying cost of inventory helps define the scope of waste in the fulfillment stream and the potential benefits of eliminating it.
Measuring Inventory Carrying Cost
Inventory carrying costs are measured by the dollar value of inventory ADOH multiplied by a predetermined inventory carrying-cost percentage. Many logistics companies struggle to determine this percentage. Breaking the task into two steps helps:
1. Identify the elements of inventory carrying costs, and
2) Then assign an estimated cost to each element. The challenge is that many of the elements are not visible on traditional financial statements and the costs will have to be estimated based on experience.
Is your logistics company using a measurement system that actually drives improvement or just provides affirmation?Share