One of the most effective methods to calculate the ERP return-on-investment is using Inventory Shrinkage rate, so first, we should explain what is the inventory shrinkage rate:-
What is the inventory shrinkage rate?
Inventory Shrinkage Rate is a KPI used to measure the rate at which the value of inventory has been reduced due to loss, theft, or inaccurate record keeping. It is calculated by subtracting the value of the inventory from the expected value of the inventory and then dividing this difference by the expected value of the inventory.
Depending on the industry, acceptable levels of inventory shrinkage rates can differ. However, it is ideal for the inventory shrinkage rate to be as close to zero as possible. Tracked over time this rate can indicate whether actions taken to prevent inventory losses are effective.
Eg: The National Retail Security Survey in 2020 finds that the inventory shrinkage is at an all-time high in the retail industry, accounting for 1.62% of a retailer’s bottom line, where seven out of 10 report an inventory shrink rate that exceeds 1%, and this costs the retail industry around $61.7 billion or £51.4 billion every year.
How can you calculate the inventory shrinkage rate?
The inventory shrinkage rate is calculated using your manual count to identify the value of inventory loss, then you can calculate the inventory shrinkage by subtracting the value of the inventory from the expected value of the inventory and then dividing this difference by the expected value of the inventory, where the value of the inventory is the value of the inventory after a manual count was obtained and the expected value of the inventory is the amount the inventory was recorded prior to any adjustments due to the physical inventory count.
For example, if your warehouse should contain 1000 pieces of a product based on the inventory records, and the unit average cost is £100 based on the average purchase price or book value. So the value of your inventory asset should be 1000 units x £100 = £100,000
When you performed a manual count you found only 900 pieces in the warehouse, and based on the inventory records this shrinkage is due to 70 damaged units, and 30 lost units.
so the value of the inventory assets based on the manual count is 900 pieces x £100 = £90,000, so the shrink equal £10,000 and can be calculated as follow
Lost quantities = 1000 pieces – 900 pieces = 100 pieces
The value of the shrinkage will be calculated as 100 pieces x £100 = £10,000
Then the inventory shrinkage rate is calculated using the following equation:-
Inventory Shrinkage rate = £10,000 / £100,000 x 100 = 10%
If the above manual count is done every month, so using your calculated rate you are losing £120,000 every year due to the inventory losses.
ERP Return-on-Investment using Inventory Shrinkage rate
A company that experiences an increasing trend or sudden spike in the inventory shrinkage rate or a high inventory shrinkage rate should investigate what the cause or causes might be and take actions in order to resolve the issues.
Identifying the reasons for inventory shrinkage and the value due to every reason, like how much is due to theft, how much is due to reporting discrepancies, and how much is due to other factors, such as the misplacement of product, is a very important step, then once you identified the reason, you should build or adjust tight processes and workflow using your ERP system. The ERP systems proved to reduce inventory shrinkage by more than 75% once it is used correctly to tackle this issue.
If your ERP implementation can solve 75% of the inventory shrinkage issue, then using the previous example, your ERP return on investment using the inventory shrinkage rate calculation is valued at £90,000 every year.