Inventory forecasting is crucial, particularly in light of the extreme variability in consumer preferences and supply networks. In order to achieve precise inventory forecasting, you need to gain insights from data analysis, industry trends, and market expertise. As Thomas Schleicher, a well-known authority in the field of measurement science, said, “Good forecasting is a blend of both art and science.”
In this post, we’re covering the fundamentals of inventory forecasting, along with formulas, inventory forecasting methods, and more.
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What Is Inventory Forecasting
Inventory forecasting is the process of determining the required levels of inventory for a future time period by evaluating sales history, historic data, seasonal trends, and upcoming events. Thanks to accurate forecasting, businesses are able to fulfill orders with sufficient inventory while at the same time preventing spending money on surplus inventory.
Why is Inventory Forecasting Important
Inventory forecasting is a crucial component of inventory management. If done correctly, it might bring a wide range of benefits for your company. Here are some of the most important ones:
Reduced stockouts and overstocks
Inaccurate inventory forecasting can sometimes result in stockouts. Although there is a demand from consumers, you don’t have enough inventory to meet it. Keeping excess stock, on the other hand, could not only increase the inventory carrying costs but also have long-term material waste effects. An excess of unsold goods may end up as solid waste in the case of spoiled or expired food products, items with a short shelf life, such as cosmetics or electronics, and out-of-style items that can’t sell, such as clothing or luxury goods.
By ordering the right amount of the goods, you can take advantage of bulk ordering without tying up money in unneeded inventory while at the same time saving on storage space.
Less manual labor
Accurate inventory forecasting reduces labor and warehousing expenses because you are better equipped to handle changes in demand. Inventory forecasting systems make it simple to anticipate future inventory requirements and lower inventory carrying costs by automating reordering, projecting labor requirements, and accounting for variations in order volume. For warehouse management and all employees, this saves time and manpower.
Increased customer and supplier satisfaction
Having products on hand increases the likelihood of repeat business and keeps customers satisfied. Understanding supplier procedures and schedules, on the other hand, also helps you reduce stock-outs and maintain positive relationships with them.
Forecasting Inventory Methods
Although intuition and past experience may have some bearing, formulas and data are the foundation of the most effective inventory forecasting. There are four different inventory forecasting methods you can use:
- Qualitative forecasting: When faced with a shortage of historical data, some businesses turn to their customers. Focus groups and market research are two common sophisticated data collection techniques used in qualitative forecasting.
- Quantitative forecasting: Using historical data, this method is thought to be more accurate than qualitative forecasting. The forecast is typically more accurate the more data an organization has. Time-series forecasting, which builds a model to anticipate future trends using temporal quantitative data, is an example of quantitative forecasting.
- Trend forecasting: Using growth data and historical sales, this technique extrapolates potential patterns while excluding seasonal impacts and inconsistencies. This forecasting method benefits from more detailed sales information that demonstrates how individual customers and customer types are likely to make purchases in the future. Using this data, analysts can develop new strategies for promotion and sales.
- Graphical forecasting: It is possible to graph the data for trend forecasting in order to display peaks and valleys in sales. The graphical approach is preferred by certain forecasters because it’s visual and offers lots of insights. This allows them to identify patterns and add slanted trend lines to graphs to analyze directions that could otherwise go unnoticed.
How to Choose the Right Inventory Forecasting Method
So, how do you decide which of these forecasting inventory methods is the best for your business?
First, think about the data you already have and the data you can obtain. The process will vary depending on the company. Established businesses should employ the quantitative method, inventory analysis, and historical data as a starting point. Newer businesses, on the other hand, might want to begin by gathering qualitative market data.
The most accurate forecasting relies on multiple data sources and forecasting inventory methods. Forecasters can get started with quantitative data, then add qualitative data, and finish with inputs specific to the industry.
What’s important is to ensure that the model takes into account the constantly shifting and frequently unanticipated trends and changes in the market that can instantly change customer demand (fashion trends or styles). Forecasters should also create several models based on historical data and various possible scenarios for tackling more difficult problems, such as a worldwide pandemic like Covid-19.
Inventory Forecasting Formulas
Understanding inventory forecasting formulas is crucial if you want to develop more complex forecasting models. They can also aid in measuring operational efficiency and pointing up potential improvement areas. Here are a few formulas you can use:
1. Safety stock
Safety stock is your reserve inventory to ensure that you have enough products on hand to fulfill customer orders. Use the following formula to calculate it:
(Maximum daily use X Maximum lead time] – (Average daily use X Average lead time) = Safety stock
2. Average inventory
This formula measures the amount of inventory you have available at any given time. Keeping it consistent over time can help you prevent stock-outs while maintaining enough inventory to meet customer demand.
(Starting inventory + ending inventory) / 2 = Average inventory
3. Inventory turnover
The inventory turnover ratio helps you see how many days it will take to sell the inventory you have on hand. A higher ratio points to strong sales.
By using the inventory turnover ratio, you can determine how many days it will take to sell your current inventory. A higher inventory turnover ratio indicates stronger sales.
Cost of goods sold (COGS) / Average inventory = Inventory Turnover Ratio
4. Economic order quantity (EOQ)
Economic order quantity is the ideal order quantity during regular times. Here’s how to calculate it:
EOQ = √2DS/H
Where D is the demand rate, S is setup costs, and H is holding costs
5. Reorder point formula
To determine the reorder point, you need to know your average daily unit sales, average lead time, and amount of safety stock. To determine your reorder point for a particular item, multiply the average unit sales by the average lead time, then add the amount of safety stock quantity.
6. Lead time
How soon after placing an order does a consumer receive the product? This formula assesses the effectiveness of your company and provides insight into customer satisfaction.
Order process time + Production lead time + Delivery lead time = Lead time
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Inventory Forecasting Best Practices
Like anything else in business, following best practices in inventory forecasting will yield better results. Here are a few steps you can take to improve the effectiveness of your inventory forecasting.
View stock levels in real time. In order to accurately forecast future demand, you need accurate and timely data. Real-time inventory tracking enables you to maintain track of current stock levels at any given time and determine whether or not your estimations were accurate or far off. If your forecasts were incorrect, be sure to determine the cause. Knowing why this occurred will enable you to use lessons from the past and modify your forecast as you go.
Know the optimal forecast period for your company. Should you make forecasts for a month, a quarter, or a year? Without using this time frame as the foundation for all of your planning, you run the risk of falling short of meeting the proper stock levels at the right times.
Get the right personnel. The ability of experienced employees to analyze data and generate accurate forecasts is a key component of inventory forecasting. You need personnel that can understand, apply, and, most importantly, analyze data in order to make the best judgments possible for your company.
Take notes you will use for future planning. This will provide context and ensure that you don’t overlook the cause of a shift in product demand. List any future flash sales, well-known holidays, and other occasions that might force your sales or production cycle to either slow down or ramp up. This way, you can review your notes from the prior year or years to make plans for the subsequent year.
Use the right software. Inventory forecasting can be challenging without specialized inventory management software. Thanks to inventory software like ApparelMagic, you’ll be able to manage your stock without using laborious and ineffective manual processes. There are many available options on the market, so take your time to choose the best solution for your industry and business.
The Bottom Line
When it comes to inventory forecasting, there is no magic wand or universal approach that works for everyone. Even if you use the best inventory forecasting tools available, inventory forecast is still just an estimate based on knowledge and experience. However, by regularly monitoring inventory turnover, stock counts, and other trends in your customers’ orders, you’ll be able to plan more precisely in the long and short-term.
Inventory management software can be a crucial part of your business’ success by ensuring you have the correct amount of stock on hand to meet consumer demand, without needlessly tying up money in excess inventory.
