Inventory issues can be a profit killer for many businesses.
The goal of managing your inventory is to hover in that sweet spot, where you have enough inventory for your customers to buy what they need, but not so much that you’ll wind up with unsellable overstock.
This shouldn’t be a guessing game. There is a science to it, and it’s called inventory forecasting. Say goodbye to discounting overstock. It’s time to cut off bad reviews that complain about out-of-stock items.
This guide will tell you everything you need to know about forecasting inventory successfully.
Inventory Forecasting Explained
Inventory forecasting is a process businesses use to predict demand for their products. At a basic level, it involves looking at past sales figures and trends to anticipate the need for certain products in the future.
Once demand estimations have been evaluated, businesses then use that prediction to decide how much stock they plan to have of each product. This is called inventory planning.
Inventory forecasting is part of the greater merchandise planning process, which ensures that a business always has the perfect balance of products on hand. Too much overstock can negatively impact profit, and so can insufficient stock.
Sales forecasting is part of the inventory forecasting process. Before predicting inventory demand, you first have to anticipate your expected sales.
How It Works
The process of demand planning begins with evaluating your current inventory situation.
- What products have you sold, and how many of each?
- What products are doing well and which aren’t?
- Are you running out of supply too quickly or struggling with overstock?
Once you know what inventory adjustments are needed to match your sales forecasting, you have to account for more complicated factors like increasing demand, seasonal changes in demand, dying trends, etc.
Next, it’s time to strategize. Businesses set sales goals and begin to make inventory decisions accordingly. The following data can be valuable:
- Present inventory numbers
- Historical trendlines
- Anticipated demand
- Seasonal demand trends
- Sales trends
- Sales velocity
The Importance of Forecasting Inventory
Though profitability is a great benefit of properly forecasting your inventory, it’s not the only one. Some additional key factors that should always be considered include marketing spend, sales promotions, and their impact on incremental POS. In the following sections, you will have the different aspects of forecasting broken down to show you the potential benefits and impact it can have on your business.
More Financial Freedom
With less of your cash tied up in inventory, you’ll have the funding available to make other investments in your business’ growth and achieve more of your business goals, sales-related or not.
In addition to not wasting money on excess goods, you’ll also be saving a lot of money by not having to pay for the extra warehouse space and workforce needed to maintain overstock.
You’ll gain so much confidence in making big decisions as a business owner when you know how to make accurate predictions. You will also learn a lot about your customers, which is an invaluable tool in the world of business.
More Customer Satisfaction
If your business struggles to keep enough stock on the shelves, poor inventory planning may be costing you more money than overstock. Customer satisfaction will drop if you never have what your customers are looking for, ultimately putting you out of business.
Different Methods of Inventory Forecasting
Ready to learn how to do inventory forecasting yourself? There are multiple approaches to demand planning, and some will work better for your business than others. The different approaches include:
- Trend Forecasting: This method only uses past sales data to predict future sales. This approach does not consider less concrete information, like potential seasonal changes.
- Graphical Forecasting: This uses the same data as trend forecasting, but in a more visual format so that it is easy to see different sales valleys and peaks over time.
- Qualitative Forecasting: In this approach, companies go directly to the source to get data: their consumers. This may include market research, surveys, focus groups, etc.
- Quantitative Forecasting: This focuses on a much broader set of company data and has its own sub-set of methods, such as the time series method and ABC method.
- Time series analysis evaluates the repetition of demand patterns and tends to be a strong source of accurate forecasting.
- The ABC method involves ranking products in terms of value (what they contribute to the company’s success) to help prioritize your stock.
Choosing a Method
One common misconception is that you should use just one method. If you have the resources available, you should actually be using more than one method to solidify your predictions. With that said, not every method is a great fit for every organization.
Do lots and lots of market research. For newer businesses, you don’t have the amount of data and history available to use quantitative forecasting accurately, so you should use the other methods instead. Qualitative research is key in these situations.
On the flip side, if you do have historical data available, you should absolutely be prioritizing quantitative forecasting, as it can be the most accurate the majority of the time. While that data should be looked at first, larger businesses should also watch forecasted trend changes.
There are lots of formulas that can be used in the inventory planning process, but there are two key calculations that every business owner should be familiar with. Regardless of which method(s) you use to head your forecasting, these numbers should also be factored into your planning.
Safety Stock Formula
Safety stock is essentially backup stock that businesses maintain in case of an emergency or sudden issue in the supply chain. Planning for the unexpected should definitely be part of your inventory forecasting process. The formula to determine your safety stock is:
(Max Daily Use of Product x Max Lead Time) – (Average Daily Use x Average Lead Time) = Amount of Safety Stock
So let’s say the most you ever move of a given product in one day is 50 units, but your average is 40 units. It usually takes a week and a half (10 days) to get new stock in, but sometimes it takes up to two weeks (14 days). We can plug in our numbers:
(50 Max Daily Use x 14 Days Lead Time) – (40 Average Use x 10 Days Lead Time) = 300 Units of Safety Stock
Reorder Point Formula
The reorder point formula is exactly what it sounds like: an indication of what point you should be reordering stock and getting more inventory.
(Average Daily Use x Average Lead Time in Days) + Safety Stock = Reorder Point
So plugging in our same numbers, it looks like this:
(40 Average Use x 10 Days Average Lead Time) + 300 Safety Stock = Reorder When Your Stock Is at 700 Units
Now that you know how to forecast inventory, avoid common mistakes and errors by following these essential best practices:
- Gather at least six months of sales history (1–2 years of data is even better).
- Utilize multiple methods of inventory forecasting.
- Don’t go it alone. A team is going to make much more thorough predictions than just one person.
- Have plans in place for the unexpected.
- Use software to organize all your data.
- Use the safety stock and reorder point formulas.
- Consider using an inventory management program or outsourcing the work to an expert.
Make Forecasting Simple with Algo
Inventory planning is essential but can be a pain to deal with. Algo offers a forecast planning system that includes machine learning capabilities and allows you to scale large assortment demand planning. This is perfect for anyone who needs advanced, high-volume forecasting. Along with these capabilities, Algo offers assistance through expert services who are focused on ensuring accuracy on every forecast. If you want to save yourself the headache, work with a supply-chain expert at Algo and reduce your personal workload with our demand and forecast planning system.
Get started by scheduling a free demo with one of our experts today!