Inventory forecasting is the process of predicting how much stock a company needs to keep up with customer demand. These predictions are informed by market research, sales data, and other variables that cause inventory levels to fluctuate.
In today’s uncertain times, companies can’t afford to leave inventory planning to guesswork. Accordingly, accurate inventory forecasts are essential to improve cash flow, satisfy customers, and stay competitive.
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This article covers what you need to know about inventory forecasting to optimize your supply chain and keep customers satisfied.
What is inventory forecasting?
Inventory forecasting refers to methods an organization uses to project how much inventory they need to fulfill future sales. This is a valuable process for product-based businesses of all sizes, including retailers, wholesalers, and distributors.
When it comes to inventory management, one of the biggest challenges is striking the right balance between healthy cash flow and optimal stock levels. That’s where inventory forecasting comes in to help supply chain managers predict how much stock they need to meet consumer demands without overstocking.
4 benefits of inventory forecasting in uncertain times
As much as businesses would love a crystal ball to see exactly how much inventory they should hang onto, that’s not possible in today’s turbulent times. However, implementing an inventory forecasting plan can give you some key advantages.
1. Reduced inventory carrying costs
Keeping excessive safety stock increases storage costs, not to mention the risk of inventory spoiling or becoming obsolete. But data-driven inventory forecasting methods let you safely gauge the optimal amount of stock to keep. These insights keep spending under control and free up space in your facility.
2. Fewer stockouts
Lost sales due to stockouts or backorders are detrimental to any company’s bottom line. Inventory forecasting mitigates that risk by considering sales history and market research, so teams don’t get blindsided by a demand surge.
For example, aligning with the marketing team about a campaign for a new product ensures you can make more accurate inventory forecasts and stock up accordingly.
4. Better business insights
Understanding how much inventory you’ll need for a specific period doesn’t just benefit buyers; it keeps reporting as accurate as possible and ensures fluctuations don’t throw budgets out of whack.
5. Better relationships with suppliers and manufacturers
Strong relationships with suppliers hinge on mutual trust. When a company accurately predicts when to place purchase orders for each SKU, the supplier or manufacturer can give more accurate lead times. This proactive approach fosters trust and saves money that would otherwise be spent on expedited production or shipping.
With the benefits of forecasting clear, here are five metrics you can use to estimate the inventory your business needs during a given period.
5 inputs you need to forecast inventory
Let’s look at the key variables every organization needs to know before they can forecast inventory.
1. Reorder point
A reorder point is a specific stock level that triggers replenishment. Calculating a reorder point ensures you don’t dip below the minimum inventory needed to fulfill orders.
Here’s the reorder point formula:
Reorder Point = (Average Daily Usage x Average Lead Time in Days) + Safety Stock
2. Safety stock
Safety stock is extra inventory held to reduce the risk of stockouts or shortages. The formula for safety stock is the difference between your maximum daily usage and lead time, and your average daily usage and lead time:
(Max. Daily Usage x Maximum Lead Time) – (Average Daily Usage x Average Lead Time)
3. Maximum stock level
This metric indicates the most units you can store for any given SKU. Understanding maximum stock levels ensures you don’t run out of space for any inventory.
This is the total time between when you place an order for inventory and when the manufacturer or distributor delivers it.
A trend is any change in demand over a specific period. For example, a swimwear brand sees an uptick in sales every May, so they know to ramp up their inventory accordingly.
Not all trends are obvious, though. As you collect more customer data, you’ll notice purchasing habits based on location, age, and market trends.
After selecting the best inputs for your business, choose a forecasting method that will effectively show how your business sees its inventory needs.
4 inventory forecasting methods
There are four types of inventory forecasting techniques to choose from, depending on your goals and how much data you have access to. You can mix and match these methods as you see fit.
1. Quantitative Forecasting
With this method, a forecaster uses numerical data to create a model that predicts future demand. The more historical data you have, the more accurate the model will be.
3. Graphical Forecasting
This method incorporates the same data as quantitative forecasting, except it conveys it in graphical form. The visual representation of data often makes it easier to spot trends and make more accurate predictions.
4. Trend Forecasting
This method considers data like market growth and past sales to project future sales trends for a specific product. Once a trend is identified, inventory managers can adjust their strategy accordingly.
5. Qualitative Forecasting
If your organization lacks historical data, gathering qualitative insights from focus groups, surveys, and market research can lay the foundation for accurate models.
After doing all the work to try and predict the future, here’s how you can get the most out of it by applying your new insights to your business.
3 ways to apply inventory forecasting
Let’s explore a few applications for inventory forecasting
1. Forecasting for more efficient operations
Leaving inventory management to guesswork is inefficient and costly. Implementing an inventory forecasting plan enables you to make more informed decisions and carry just enough inventory, with techniques like just-in-time manufacturing, without overspending.
2. Forecasting for new products
Demand forecasting for a new product is difficult because there isn’t historical data to rely on. However, analysts can leverage data from similar products as well as qualitative data to make evidence-based predictions.
Forecasting models for new products should account for any marketing initiatives or seasonal trends influencing purchasing habits.
3. Forecasting for seasonal products
If a company has a seasonal product, analysts use a combination of qualitative data (weather, market trends) and quantitative data (past demand, historical sales data) to make their demand planning as accurate as possible.
Inventory forecasting tools
As your business becomes more complex, so does inventory forecasting. Here are a few common tools you can use during the forecasting process.
If your business has a limited product catalog, a simple spreadsheet can run the basic calculations you need to forecast inventory.
2. Third-party logistics provider
If you outsource your order fulfillment to a third-party logistics (3PL) company, they may have the capabilities to create sophisticated models internally.
4. Inventory management software
Whether you sell five or 5,000 products, inventory management software is a valuable tool to gain efficiencies in your supply chain.
Enterprise also automates inventory tasks so you can minimize surplus and reduce the risk of human errors that slow your momentum.
Best practices for inventory forecasting
Here are three tips to keep in mind to get the most value out of inventory forecasting:
Get the whole team involved
Inventory forecasting is a team sport. Before making any bold predictions, seek input from stakeholders in every department, including marketing, finance, and product development. The more information you have, the more accurate your forecasts will be.
Invest in real-time inventory tracking
Spreadsheets are cheap, but there’s a big tradeoff: since you have to update them manually, they can only give a static snapshot of inventory levels. On the other hand, inventory management software automates this process so you can spend less time tracking SKUs and more time making key decisions.
Take notes to inform future forecasts
Sometimes data alone isn’t enough to make accurate predictions. You need qualitative notes to contextualize inventory trends.
For example, if a social media post mentioning your brand went viral and caused a spike in sales, you wouldn’t incorporate that fluke event into next year’s projection. However, if you notice a demand surge around Father’s Day, you can expect a similar trend next year.
Inventory forecasting isn’t an exact science. But at the end of the day, a strong estimate is better than no estimate at all, especially when supply chains are vulnerable.
Think of it like a weather forecast: millions of people check the weather app on their smartphones every morning so they know whether to pack an umbrella or an extra layer. Even if the data isn’t 100% accurate, you have a good sense of what to expect that day.
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