How to Perform Inventory Analysis: Types, Methods, KPIs, and Goals

mark599704
24 hours ago
11 min read

Efficient inventory management is the backbone of any successful business. Inventory analysis not only ensures you always have the right products ready for customers but also keeps costs under control, boosts cash flow, and maximizes profits. In this guide, we break down the most effective tips, proven methods, and essential metrics to help you master your inventory like a pro.

What Is Inventory Analysis?

Inventory analysis helps you know the right amount of stock to keep. It ensures you can meet demand without spending too much on storage. Inventory is an asset on the balance sheet. It shows the products a company plans to sell to customers. Inventory includes finished goods, raw materials used to make products, and work-in-progress goods. For example, a washing machine being assembled is a work-in-progress. Read our guide to learn more about different types of inventory.

What Are the 4 Types of Inventory?

The four most common types of inventory are Finished Goods, Raw Materials, Work-In-Process (WIP), and Overhaul / MRO Inventory. Knowing the type of inventory your business has helps you manage it more effectively. This includes practicing better inventory control and choosing the right inventory management to track all stock efficiently.

1. Finished Goods Inventory

Finished goods inventory includes products that are fully completed and ready to be sold or used by customers. Any item that can be delivered or consumed without further processing is considered a finished good. For example, finished goods could be a handcrafted leather wallet ready for online sale, a set of artisan candles packaged for retail, or a batch of custom-printed t-shirts ready to ship.

In the medical industry, supplies and materials that are ready to use are also considered finished goods, even if they are not sold. However, production must be fully complete. For instance, a vaccine cannot be considered a finished good until it is fully prepared and ready for use. It is important to understand that the category of an item depends on how it is used by a business. For example, a manufacturer might consider steel or lumber finished goods, while a construction company would classify the same items as raw materials.

2. Raw Materials Inventory

Raw materials are the basic items needed to turn inventory into finished products. These are components that are in stock but have not yet been used in work-in-process or finished goods inventory. For example, in the construction industry, raw materials include lumber, steel, and copper used to complete projects. In manufacturing, raw materials like cotton can be used to make finished products, such as t-shirts sold in stores.

Even though raw materials are not yet finished products, they hold significant value and are essential for operations. Tracking raw materials is crucial, as many industries rely on them to sustain production and deliver services.

3. Work-In-Process (WIP) Inventory

Work-in-process (WIP) inventory includes items that are currently being manufactured. From a cost perspective, WIP consists of raw materials that are in production at the end of an accounting period. Simply put, any raw materials your business is using to create finished goods are considered WIP inventory. WIP inventory is common in manufacturing and food and beverage industries.

For example, WIP could include cars still on an assembly line or coffee beans that have not yet been roasted. Another example is a custom wedding dress that is not finished by the end of the fiscal year. The lace, silk, and taffeta are no longer raw materials, but the dress is not yet a finished product ready to sell.

4. Overhaul / MRO Inventory

Overhaul or MRO inventory, also called maintenance, repair, and operations inventory, includes items used to maintain assets and support daily business activities. This type of inventory ensures that equipment and operations run smoothly and efficiently. For example, in manufacturing, hard hats and safety goggles used during production are part of MRO inventory. In construction, repair parts for heavy machinery and industrial lubricants are also considered MRO inventory because they help prevent downtime and keep projects on schedule.

MRO inventory also covers consumable supplies needed for day-to-day business operations. For instance, most offices require pens, paper, ink cartridges, cleaning supplies, and similar items to provide their services effectively.

8 Common Inventory Analysis Methods

There are several methods you can use to perform inventory analysis. The best method depends on your industry and the type of inventory you manage. Below are the most common techniques and the industries that typically use them:

1. ABC (Value Analysis)

One of the most popular methods for inventory analysis is ABC, also called “Always Better Control.” This method helps retailers classify inventory based on each item’s value and its impact on annual inventory costs. ABC analysis divides inventory into three categories:

A-inventory: These are the most valuable products, contributing the most to profits.
B-inventory: These are mid-value items, falling between the most and least valuable products.
C-inventory: These are low-value items that have small individual costs but are important for overall profit margins.

Using ABC analysis allows businesses to focus more on the most important inventory items, which can boost revenue and help control costs. This strategy also helps reduce dead stock, optimize inventory turnover, and improve demand forecasting.

2. VED (Functional Analysis)

VED analysis classifies inventory based on how important it is to have an item in stock. This method is often used by manufacturing companies that store many different components and parts. Unlike ABC analysis, VED focuses on the necessity of an item for the ongoing operation of the business, rather than its monetary value. VED inventory is typically divided into three categories:

Vital: Items that must always be in stock.
Essential: Items for which a minimum stock is sufficient.
Desirable: Items that are optional to keep in inventory.

VED analysis helps determine how critical an item is and how its availability affects production or other business operations.

3. HML (Unit Price Analysis)

HML analysis classifies inventory based on the cost per item, or unit price. This method helps businesses understand the value of each item in stock and manage inventory costs effectively. HML analysis divides inventory into three categories:

High Cost: Items with a high unit value.
Medium Cost: Items with a medium unit value.
Low Cost: Items with a low unit value. These items should be listed in descending order of unit price, and it is up to the business to set the limits for each category.

Although HML focuses only on the unit price and does not consider the sales value of each item, it is still useful for controlling costs and staying within budget.

4. SDE (Scarcity Analysis)

The SDE inventory analysis method focuses on how scarce items are in the market and how quickly a company can acquire them. This approach classifies inventory based on the availability and lead time of each item or SKU. Scarce products are often imported, which means they may take longer to arrive or be harder to source. SDE analysis divides inventory into three categories:

Scarce: Imported items with long lead times.
Difficult: Items with lead times ranging from a few weeks to six months.
Easily Available: Items that are readily acquired.

Businesses using the SDE method often deal with raw materials or other items that require long lead times before they can be used in production.

5. Economic Order Quantity (EOQ)

Economic Order Quantity (EOQ) is a method that evaluates the sales rate of an item along with its ordering and storage costs. Using these three factors, EOQ determines the optimal quantity and frequency of orders. The goal is to minimize both ordering and storage costs while ensuring that all customer orders can be fulfilled.

6. Material Requirements Planning (MRP)

Material Requirements Planning (MRP) is a method where manufacturers order inventory based on sales forecasts and stock data from different parts of the company. For example, a swimwear manufacturer would order more inventory in the months leading up to peak demand to ensure sufficient stock.

7. Fast, Slow, and Non-Moving (FSN)

The FSN method categorizes inventory into three types: fast-moving, slow-moving, and non-moving items. Managers use this classification to decide when and how much to reorder. Fast-moving items are reordered most frequently to meet customer demand efficiently.

8. Custom Par Levels

Custom Par Levels set a specific inventory amount at which each item must be reordered. Although this method requires extra effort at the start, it helps ensure that the organization rarely runs out of stock and maintains smooth operations.

8 Goals of Inventory Analysis

Inventory analysis helps a company lower costs, reduce theft, manage cash flow, and make sure it always has the products customers want to buy.

1. Find Areas to Improve:

Monitoring inventory helps identify which products sell well and which sell poorly. This information allows businesses to optimize shelf space and improve supplier relationships.

2. Minimize Stockouts and Backorders:

When a product is not available, customers may have to wait or buy from competitors. Proper inventory analysis helps prevent stockouts and backorders, keeping customers satisfied.

3. Diminish Wasted Inventory:

Excess inventory can become obsolete, degrade, or lose value over time. Regular inventory analysis prevents these losses and helps the business operate efficiently.

4. Improve Cashflow:

Having the products customers want increases sales and improves incoming cash flow. Strong cash flow helps pay suppliers on time and supports business operations.

5. Increase Profits:

Keeping the right amount of inventory allows a business to grow sales while cutting unnecessary expenses. This balance directly increases profits over time.

6. Stop Project Delays:

Inventory analysis ensures that materials for special projects are available when needed. This prevents production delays by giving enough time to reorder supplies.

7. Reduce Capital Costs:

Buying only what is needed frees up cash and capital for other investments. This ensures that money is not tied up unnecessarily in stock.

8. Decrease Storage and Related Expenses:

Avoiding excess inventory reduces storage and handling costs. It also lowers losses caused by damage, spoilage, or expired products.

Common Mistakes to Avoid When Selling Excess Inventory Online

9 Key Inventory Analysis Metrics

Key inventory metrics, also called KPIs, help you evaluate how effectively your company manages inventory. Some of the most popular metrics include inventory turnover rate, available-to-promise stock, stockout rate, and sell-through rate. These metrics provide insight into stock efficiency, demand fulfillment, and overall inventory performance.

1. Inventory Turnover Ratio

The inventory turnover ratio measures how many times a company sells and replaces its inventory during a specific period. A higher turnover rate indicates that the business is selling products quickly without overstocking, which reflects efficient inventory management. To calculate turnover for yourself, you can use the formula:

ITR = Cost of goods sold (COGS) during the specified period / Average inventory during the period

2. Days Inventory Outstanding (DIO)

Days Inventory Outstanding (DIO), also called “days in inventory,” measures the average number of days a company holds inventory before selling it. This metric shows how quickly a business can turn its stock, making it an important indicator of operational and financial efficiency. To calculate DIO, you can use the standard days-in-inventory formula, which helps determine how long inventory sits before being sold.

Days Inventory Outstanding = [average inventory ÷ cost of sales] x number of days in period.

3. Gross Margin Return on Investment (GMROI)

Gross Margin Return on Investment (GMROI) shows how much profit a business earns for every dollar spent on inventory. In other words, GMROI measures the return on the funds invested in stock, helping business owners evaluate the profitability of their inventory. To calculate GMROI for your own company, use the formula:

GMROI = Gross profit margin / average cost of inventory on hand

4. Stockout Rate

Stockout rate measures the percentage of items that are unavailable on the buyer’s requested date. This KPI shows a company’s inability to deliver products from stock within the promised timeframe due to insufficient inventory. Stockout rate is often used to evaluate how effectively a business replenishes inventory within its distribution network. The formula is:

SR = (Stockout order / total customer orders) x 100

5. Customer Service Level (CSL)

Customer Service Level (CSL) measures the probability of fulfilling customer orders without experiencing a stockout, which helps prevent lost sales. This metric is expressed as a percentage and indicates how well a company meets customer demand on time. The formula for CSL is:

CSL = (Products delivered on time ÷ Total products sold) × 100

6. Available to Promise (ATP)

Available to Promise (ATP) measures the quantity of a product that a company currently has or will have available to fulfill customer orders. Businesses use ATP to provide accurate delivery dates to customers based on inventory and planned supply. The formula for ATP is:

ATP = Quantity on hand + Supply (planned orders) - Demand (sales orders)

7. Back Order Rate

Back Order Rate measures the portion of total customer orders that cannot be fulfilled immediately due to inventory shortages, resulting in delayed delivery. This KPI is expressed as a percentage and highlights potential issues in inventory planning or stock management. The formula for Back Order Rate is:

Back Order Rate = (Total back orders ÷ Total orders) × 100

8. Sell-Through Rate (STR)

Sell-Through Rate measures the percentage of an item sold during a specific period compared to the total inventory received during that same period. This KPI is especially important in the retail industry, as it indicates how quickly products are selling. The formula for STR is:

STR = (Total sales during period ÷ Inventory received during period) × 100

9. Inventory Write-Offs

An inventory write-off formally recognizes the portion of inventory that no longer has value. Typically, a write-off is recorded in one of two ways: it is either expensed directly to the cost of goods sold (COGS) account or deducted from the inventory asset account. Write-offs occur when stock is damaged, spoiled, obsolete, or stolen. If inventory only loses value but is not completely lost, it is usually written down rather than fully written off.

Qualitative Analysis of Inventory

Companies often analyze inventory beyond standard KPIs by considering additional practices that help manage stock effectively. These qualitative factors focus on operational efficiency, product value, and cash management.

Just-in-Time (JIT) Ordering

In JIT ordering, a company keeps only enough inventory to fulfill current customer orders. This approach reduces storage and related costs but requires careful planning to ensure materials and products arrive on time.

Cash Availability

Limited cash or financing options may restrict how much a company can invest in inventory. Managing available funds carefully ensures the business maintains stock without overextending financially.

Order Fulfillment Philosophy

To provide fast turnaround for popular products, a company may maintain higher inventory levels of those items. This ensures customer orders are fulfilled quickly and consistently.

Inventory Obsolescence

In industries like fashion or beauty, products may lose value quickly. Companies must limit the inventory of items that can become obsolete and unsellable to reduce losses.

Conclusion

Inventory analysis is essential for every business that manages physical products. By understanding inventory types, applying appropriate analysis methods, tracking key metrics, and considering qualitative factors, companies can optimize stock, reduce warehouse costs, and increase customer satisfaction. A well-managed inventory not only supports smooth operations but also contributes directly to profitability and long-term business success.

Frequently Asked Questions (FAQs)

1. What is inventory analysis, and why is it important?

Inventory analysis is the process of evaluating a company’s stock to ensure the right amount of products are available at the right time. It helps reduce storage costs, prevent stockouts, improve cash flow, and increase overall operational efficiency.

2. What are the main types of inventory?

The four primary types are Raw Materials, Work-In-Process (WIP), Finished Goods, and Maintenance, Repair, and Operations (MRO). Each type plays a specific role in production, sales, or operational support, and understanding them helps improve inventory management.

3. How do I choose the best inventory analysis method for my business?

The best method depends on your industry, product type, and business goals. Popular techniques include ABC (value-based), HML (unit price-based), VED (functional importance), FSN (movement-based), and EOQ (cost optimization). Using the right method helps manage stock efficiently and reduce costs.

4. What are the key metrics (KPIs) for inventory management?

Important inventory KPIs include Inventory Turnover Ratio, Days Inventory Outstanding (DIO), Sell-Through Rate (STR), Stockout Rate, Available-to-Promise (ATP), and Customer Service Level (CSL). These metrics provide insight into stock efficiency, demand fulfillment, and profitability.

5. How can qualitative analysis improve inventory management?

Qualitative analysis considers operational practices beyond numbers, such as Just-in-Time (JIT) ordering, order fulfillment philosophy, inventory obsolescence, and cash availability. It ensures companies make smarter inventory decisions, reduce waste, and maintain smooth operations.

6. How does inventory analysis impact business profitability?

Effective inventory analysis helps prevent overstocking, reduce losses from obsolescence, improve cash flow, and increase sales by keeping products available when customers want them. These improvements directly boost profitability and operational efficiency.