When you plan a trip abroad, you will likely look at the weather forecast to ensure you don’t have to spend two weeks in your hotel room, watching foreign TV, and eating pot noodles because it’s raining outside.
Forecasting in inventory management is at least as important in the business world. Your employees and customers will even care more about your inventory than your holiday.
Incorrectly forecasting your inventory may cause you to be stuck with a room full of unsold products or, even worse, drive customers away who are willing to pay top dollar for your goods since you have nothing in stock.
To make sure this doesn’t happen, we’ve compiled the ultimate guide to inventory forecasting, so sit back, grab your favorite beverage, and keep reading.
What is inventory forecasting?
Inventory forecasting, demand planning, or demand forecasting is the process of estimating future inventory needs based on past sales and production data. This information can be used to develop a plan for ordering and stocking inventory and to predict when shortages may occur.
There are a lot of different qualitative and quantitative methods that can be used to forecast inventory needs. Each method has its own advantages and disadvantages, but not to worry — we’ll get into more details soon.
The goal of inventory forecasting
The goal of inventory forecasting is to accurately predict future demand so that businesses can have the right amount of stock on hand at all times. This helps to avoid both stock-outs and excess inventory, which can tie up capital and increase storage costs.
Inventory forecasting is an important tool for businesses of all sizes, but it can be especially critical for small businesses with limited capital. By using inventory forecasting to plan ahead, companies can ensure that they have the products their customers want when they need them without tying up too much money in inventory.
In today’s competitive marketplace, being able to meet customer demand is essential for success. With the help of inventory forecasting, businesses can keep their shelves stocked and their customers happy.
Benefits of accurate inventory forecasts
Before we scare you away with the time-consuming and sometimes expensive methods of forecasting inventory, let’s take a step back and look at the benefits of accurate inventory forecasts.
Improved customer satisfaction
Your customers are putting the bread on your table, so it’s no wonder their satisfaction is at the top of the list.
If your customers can’t find the products they need when they need them, they won’t be sticking around for very long. While some may come back at a later date to see if you’ve filled your empty shelves, others may never give you a second chance and will do their shopping with your competitor instead.
For a business, it’s a lot easier and cheaper to keep a loyal customer than it is to gain a new one, so you should always take care of them first.
You can avoid stock-outs and keep your customers happy with accurate inventory forecasting. By stocking the products your customers want, when they want them, you can keep benefitting from their repeat business.
While accurate inventory forecasting may require some upfront investment, it can save your business money in the long run.
Holding too much inventory gets costly, as every product you hold incurs a carrying cost, which includes the cost of warehouse space, labor, packaging, and insurance. Reducing the amount of inventory you need to store can also reduce your carrying costs.
On the other hand, holding too little inventory can also be costly. If you run out of a product that your customers want, you may lose their business entirely. In some cases, you may even have to pay expedited shipping costs to get more products in stock quickly.
In addition, if you can forecast inventory needs accurately, you can take advantage of quantity discounts suppliers offer. Buying products in bulk can save your business money, which can offset the cost of forecasting inventory.
By using inventory forecasting, you can find the sweet spot between too much and too little inventory, saving your business money in the long run.
Improved cash flow
Another benefit of accurate inventory forecasting is improved cash flow.
If you carry too much inventory, you tie up capital that could be used for other purposes, such as investing in new products or marketing campaigns. You can free up this cash with accurate inventory forecasting and put it to work elsewhere in your business.
On the other hand, if you don’t have enough inventory on hand to cover all the demand, you may have to borrow money to cover the cost of new inventory. This can lead to increased debt and higher interest payments, which can strain your business’s finances.
If customers know that you always have the products they need in stock, they are more likely to buy from you instead of going to a competitor. In addition, being able to meet customer demand can lead to increased sales, as customers are more likely to buy additional items when they’re already in your store or browsing your website.
Now that you’re aware of the benefits, let’s learn how to forecast inventory with different methods. These may seem complex and resource-heavy, but the benefits will definitely outweigh the costs when implemented correctly.
Inventory forecasting methods
Several methods can be used to forecast inventory needs, but most of them fall under qualitative or quantitative approaches.
Quantitative methods are mathematical and statistical techniques used to analyze data.
These methods can be used to describe, predict, and understand relationships between variables. There are many different types of quantitative methods, but they all have one thing in common — they make use of numerical data. This means that quantitative methods are particularly well suited for analyzing inventory data.
Let’s go over some of them and see how you can implement these in your forecasting.
One popular quantitative method is trend analysis. This approach looks at past sales data to identify whether demand increases, decreases, or stays the same. This information can then be used to predict future inventory needs.
You need your sales data for the period to conduct a trend analysis. This data can be gathered from historical sales records or other sources. Once you have this data, you can begin to identify trends.
There are two types of trends that you can look for:
- Linear trend — A linear trend is a straight line. Linear trends can be positive, negative, or flat. A positive linear trend means that the demand is increasing over time. A negative linear trend means that the demand is decreasing over time. And a flat trend means there’s no distinguishable trend over the given period
- Nonlinear trend — A nonlinear trend is any trend that is not a straight line. Nonlinear trends can be caused by a number of factors, such as changes in the market or the introduction of new products
Once you have identified the type of trend, you can begin to predict future changes in the variable. To do this, you can use trend lines. A trend line is a line that is drawn on a graph to show the direction of a trend.
There are two types of trend lines:
- A moving average trend line — Created by averaging the data points over a specific period. This type of trend line is often used to smooth out fluctuations in the data
- A regression trend line — Created by using a statistical technique called regression analysis. This type of trend line is more accurate than a moving average trend line, but it is also more complex to create
In the case of messy data, identifying the trend can be quite hard. To make it easier, you can use moving averages.
To determine a trend, you can add two moving averages together, one for a shorter period of time and one for a longer period. The difference between the two moving averages will tell you if the trend is increasing, decreasing, or staying the same:
- Increasing trend — The longer moving average is higher than the shorter moving average
- Decreasing trend — The shorter moving average is higher than the longer moving average
- No trend — The two moving averages are equal
Once the trend type has been identified, you can use historical sales data to predict future demand. For example, if you believe demand will continue to increase, you can order more inventory. If you believe demand will decrease, you can order less inventory.
There are several advantages to using trend analysis:
- It’s a relatively simple method that doesn’t require a lot of data
- It can be used to predict both short-term and long-term demand
- It can help to identify changes in demand over time, which can help businesses adjust their inventory levels accordingly
However, there are also some drawbacks to using trend analysis:
- It only looks at historical data, so it can’t account for changing market conditions
- It can be difficult to identify the correct trend type
- It may not be accurate if there are sudden changes in demand
Another quantitative method is regression analysis.
This approach uses historical sales data to identify relationships between different factors, such as price, promotions, and seasonality. This information can then be used to predict how changes in these factors will impact future demand.
Regression analysis is a more complex method than trend analysis, but it can be more accurate. This is because it can take into account multiple factors that might impact demand.
As to not get too technical, we’ll briefly steer away from inventory management. However, be warned, there will be some math ahead.
Let’s imagine that we need to predict a person’s weight based only on their height. Luckily, we can recall the statistics class when we learned about linear regression, so we confidently take on the task given.
We are given collected data containing weights and heights of 100 people. We can use linear regression analysis to find the line of best fit for this data. Let’s say that the equation for the line of best fit is y = 2.5x + 30. This equation means that, for every 1 unit increase in height, the weight will increase by 2.5 units.
Now, let’s say that we need to estimate the weight of a person who is 70 inches tall. We would do the following calculations:
y = 2.5x + 30
y = 2.5 x 70 + 30
y = 175 + 30
y = 205 pounds
This calculation tells us that a person who is 70 inches tall weighs 205 pounds. Of course, this is just an estimate, and the actual weight could be different. However, this example shows how linear regression can be used to predict future values.
In general, linear regression analysis is a powerful tool that can be used to estimate the value of one variable based on the values of another variable.
The advantages of regression analysis:
- It can be used to identify relationships between different factors
- It can help to predict how changes in these factors will impact demand
- It can be used to identify potential problems before they occur
Some cons to using regression analysis:
- It can be time-consuming and expensive to collect all of the data needed for the analysis
- It can be difficult to identify the correct relationships between different factors
- It can be inaccurate in case there are sudden changes in demand
Simplify the data collection with an ERP
If you’re using an ERP like Katana, the hardest work is already done for you, as you can easily access all the relevant data directly from the platform.
Katana allows you to select a period, and it will show you a line graph with revenue, profit, and COGS nicely displayed. You can also filter the data by:
This gives you a clear visual overview of your sales performance over the selected period, making it easy to see how the demand changes over time.
Being able to filter by location is particularly useful, as it allows you to see how demand varies from one location to another. For example, you might find that demand is increasing in one location but decreasing in another. This information can be used to make decisions about where to focus your efforts.
In general, trend analysis is a helpful tool that can be used to predict future demand. However, it’s important to remember that it has its limitations. As with any forecasting method, it’s always best to use multiple methods in order to get the most accurate picture of future demand.
Inventory forecasting formula
There is no one-size-fits-all inventory forecasting formula. The most appropriate method or combination of methods will depend on the business and available data. Though we understand that’s not what you want to hear, there are some general guidelines you can follow.
Before we take a look at the calculations, let’s go over some terminology:
- Reorder point — the minimum inventory level at which a new order should be placed
- Lead time — the amount of time it takes to receive a new shipment after an order
- Average daily demand — the average number of units sold per day
- Safety stock — the extra inventory kept on hand to meet unexpected spikes in demand
Now that we’ve got that out of the way, let’s dive into the formulas.
Two main formulas are used in inventory forecasting:
- The reorder point formula
- The safety stock formula
Let’s go over both of them.
Reorder point formula
4 inventory forecasting best practices
There are some things you need to take into account to ensure your forecasts are accurate. Here are some of the best practices when it comes to inventory forecasting.
1. Use data
As mentioned before, data is key to making accurate forecasts. Make sure to use data from as many sources as possible, including sales, production, supplier, and shipping data.
If you’re not sure where to start, try using software like an ERP that can help you collect and analyze all of your data in one place.
2. Be flexible
The market is always changing, so it’s important to be flexible in your forecasting. If you see that your sales are trending downward, don’t be afraid to adjust your forecast accordingly.
It’s also important to be flexible in your inventory management. If you find that you’re not selling as much of a certain product as you thought, don’t be afraid to adjust your inventory levels.
3. Test and refine
The best way to hone your forecasting skills is to test and refine your methods constantly. After you’ve created a forecast, compare it against actual sales data. If there are discrepancies, take a closer look at your methods and see where you can make adjustments.
Over time, you’ll develop a more accurate forecast by constantly testing and refining your methods. By constantly tweaking your process, you’ll be able to create more accurate predictions that can help guide your business decisions.
4. Communicate with stakeholders
Inventory forecasting can be complex, so it’s important to communicate your plans and methods to all relevant stakeholders. This includes managers, sales staff, production staff, and suppliers.
By keeping everyone in the loop, you can avoid misunderstandings and ensure that everyone is working towards the same goal.
4 mistakes in inventory forecasting
Now that we’ve gone over some of the best practices made in inventory forecasting let’s look at the most common mistakes.
1. Not accounting for seasonality
If your business experiences peaks and valleys in demand throughout the year, consider this in your forecast. Seasonal adjustments can be made by looking at historical sales data and identifying patterns.
2. Failing to account for changes in the market
The market is always changing, and your forecasting should reflect that. Whether it’s a change in customer needs or a new competitor, ensure you consider all relevant factors when making your forecast.
3. Relying on gut instinct
Gut instinct can be helpful, but it’s not always accurate. When making forecasts, be sure to use data-driven methods such as trend analysis to ensure you’re getting the most accurate picture possible.
4. Not being realistic
It’s important to be realistic when making forecasts. If your forecast is too optimistic, you may end up with excess inventory. On the other hand, if it’s too pessimistic, you could run into stock-outs. Find a happy medium by using data to inform your forecast.
Leverage your ERP software to simplify inventory forecasting
As you can see, forecasting inventory can be very involved and resource-heavy. Fortunately, there are software solutions that can greatly simplify the process.
Katana’s ERP can keep track of all the relevant data about your purchases, sales, and manufacturing. The insights feature allows you to track your sales performance, monitor your revenue, profits, costs, and spot sales trends.
Katana’s manufacturing ERP supports multiple locations, so you can have a granular overview of every manufacturing facility and warehouse. This allows you to make changes in your manufacturing and storage processes based on the demand in certain locations.
With Katana, You also have the option to manage your bills of materials (BOMs) and set reorder points, making Katana the perfect platform for tracking and managing your inventory.
Besides the robust inventory management features, Katana seamlessly integrates with accounting, CRM, e-commerce, and other tools to provide a complete picture of your company’s operations. This helps keep all your business tools synchronized and up-to-date without manually copying and pasting everything.
You can try out Katana with a free 14-day trial to see how it can streamline your inventory management processes and improve your entire business operations.