Supply Chain Management Tools – Techniques, Ratios, Formula

Supply Chain Management is that area of expertise that deals with the management of the supply chain activities of any company or entity in order to maximise the value for customers by achieving a competitive and sustainable advantage. Cost efficiency in the delivery of service and products is at the helm of supply chain management. This includes everything and every activity from the development of the product through the sourcing, acquiring, producing and logistics aspects, through a well-coordinated network.

Supply chain strategies have gained prominence in the business organizational structures of today. The control of inventory and its visibility have become critical elements in business operations and are one of the prime drivers that impact the financials of any company. There are certain metrics in supply chain management that are decisive performance indicators that corporations use.

Supply Chain Management Tools

Some of the most important supply chain metrics are as follows:

Inventory Velocity

Inventory Velocity is described as the is the percentage of inventory the company is projecting to consume within the next time period. Inventory Velocity = (Opening Stock / Next Month’s Sales Forecast) This metric is important as it helps in the understanding of the match of the inventory in hand to its demand. Monthly tracking of Inventory Velocity sheds light on the areas of improvement with regards to realigning the inventory level to meet optimal levels of results. It works in matching the supply with demand and prevents the needs for excessive stocking in the warehouses.

Perfect Order Measurement

Perfect Order Measurement = [(Total orders – Error orders) / Total orders] × 100

This metric is important as it calculates the percentage of orders that are free from errors.  It calculates the rate of error-free delivery for each stage of a purchase order. These errors can be in the form of procurement forecasting error, warehouse pickup processing error, invoicing error, shipping order errors, etc. It can be broken down stage-wise as:

• 99.98 percent perfect for warehousing

• 99.02 percent perfect for transportation

• 99.12 percent perfect for production

• 99.99 percent perfect for procurement

Inventory Turnover Ratio

Inventory Turnover Ratio (ITR) = Cost of Goods/ [(Opening Stock – Closing Stock) / 2]

The Inventory Turnover ratio helps determine the number of times a company sells or turns the average inventory that is kept in the storehouses. Therefore, in other words, it is a measure of opportunities to make profits from the working capital that is invested in the form of inventory.

Cash to Cash Cycle Time

Cash to Cash Cycle Time = Materials payment date – Customer order payment date

This ratio measures the number of days between the payment of materials to the getting the payment for the product. It is averaged on a weekly, monthly or quarterly basis. The ratio tells of the amount of time the operating capital is tied up for and it is important from the point of view that cash tied up is unavailable for use for other purposes. A smooth cash to cash operation denotes a supply chain that is profitable.

Days of Supply

Days of Supply = [Average inventory on hand (as value) / Average monthly demand (as value)] × 30 (for measurement on a monthly basis)

This forms one of the key performance indicators that measure the efficiency in supply chain.

Days Sales Outstanding

Days Sales Outstanding = (Receivables/Sales) × Days in Period

This metric provides a measure of how quickly revenue can be collected from clients. The lower the day’s sales outstanding number, the more efficient a business.

Inventory Turnover

Inventory Turnover = (Cost of Goods / Average Inventory)

The Inventory Turnover denotes the number of times a company’s inventory cycle takes place during a year. A high turnover means the supply chain is efficiently managed.

Customer Order Cycle Time

Customer Order Cycle Time = (Actual delivery date – Purchase order creation date)

This ratio measures the amount of time it takes to deliver an order to the customer after the purchase order (PO) has been received. Another variant of this ratio is expressed as: Customer Order Cycle Time = requested delivery date – purchase order creation date

Gross Margin Return on Investment

Gross Margin Return on Investment (GMROI) = [Gross Profit] / [(Opening Stock-Closing Stock) / 2] × 100

The GMROI ratio is indicative of the gross profit that is earned for every average investment that is made with regards to inventory. Tracking this metric on a monthly cycle helps in identifying which item produces a higher gross profit in the inventory.

Turn-Earn Index

Turn-Earn Index (TEI) = (ITR) x (Gross Profit %) × 100

TEI enables in combining the gross margin and turnover. The idea is to keep the Inventory Turnover Ratio high for those products that generate low margins. This way the ITR is kept at medium or low for those products that generate high margins.

On Time Shipping Rate

On Time Shipping Rate = (Number of On Time Items / Total Items) × 100

This ratio denotes the percentage of items, Stock-keeping unit or order value that is received on or before the requested ship date. It is an important metric as on-time delivery rate indicates that customers are kept satisfied and higher the rate the more efficient the supply chain.

Fill Rate

Fill Rate = [1 – ((Total Items – Shipped Items) / Total Items)] × 100

The Fill rate is important to customer satisfaction and has its implications for efficiency with regards to transportation. This ratio indicates the percentage of a customer’s order filled on the first shipment.

Average Payment Period for Production Materials

Average Payment Period for Production Materials = (Materials Payable/Total Cost of Materials) × Days in Period

This the average time from the time of the receipt of materials to the time of payment for those materials. It does a company well to pay the suppliers slowly as the longer the average payment period, the more efficient is the business.

Supply Chain Cycle Time

This is the time it takes to fill a customer order if the levels of inventory were zero. It is the sum of the longest lead times that are taken at each stage of the cycle. This time tells of the overall efficiency of the supply chain management. If the cycles are shorter it means a more efficient supply chain. Looking at this metric helps identify the pain points and uncover competitive advantages.

Inventory Days of Supply

Inventory Days of Supply = (Inventory on hand / Average daily usage)

This metric shows the number of days that it would take for a company to run out of supply if it is not refilled. The goal of supply chain management is to minimize the days and hence, minimize the risk of excess inventory lying around. The obsolete inventory curtails the operational cash flow.

Freight cost per unit

Freight cost per unit = (Total freight cost / Number of items)

The SCM aims to minimize this cost per unit to achieve operational efficiency.

Freight bill accuracy

Freight bill accuracy = (error-free freight bills / total freight bills) × 100

This number shows the percentage of error-free freight bills. Accuracy in matters of billing is crucial for profitability and for the satisfaction of customers.