Inventory Forecasting: What is It and Why is It Important?

Effective inventory forecasting is the backbone of a well-oiled supply chain. It ensures that you have the right products ready when your customers want them. It’s a time-tested way to maintain cash flow, minimise product waste and boost customer satisfaction. 

On the flip side, poor inventory forecasting can quietly eat away at your business. It lowers profits, damages your reputation, and leaves customers unhappy. 

Inventory forecasting is a valuable tool to boost revenue and slash unnecessary costs. But the more retailers understand the basics of forecasting inventory, what it can realistically achieve for them now, and which techniques suit their current needs, the more potent a tool it becomes for them. 

So in this guide, you’ll learn the essentials of this often underestimated aspect of inventory management. It will reveal insights to transform your inventory strategies and ensure long-term success.

What is Inventory Forecasting?

Inventory forecasting, or inventory demand planning, is about predicting the stock needed to meet expected product demand. It analyses historical data, market trends, etc., to help businesses project future sales.

Accurate inventory forecasts ensure you have enough stock for customer orders. Yes, it also includes safety stock for seasonal demand or supply chain issues. 

Inventory forecast is a great way to avoid overstocking and tying up excess capital. Get it right and it reduces the risk of having an obsolete inventory. 

Whether you're an eCommerce brand or a brick-and-mortar store, inventory management and demand forecasting are vital to match your sales pace. 

For a retail store, inventory forecasting predicts how much you're likely to sell. So that you know whether your shelves are well-stocked or if popular items face depletion. 

Similarly, eCommerce inventory forecasting ensures your fulfilment warehouse has the right inventory to fulfil orders, avoiding unnecessary stock accumulation.

In short, inventory forecasting identifies the best time and amount to restock shelves. 

Forecasting inventory demand involves pulling in data from various sources. This involves analysing historical and real-time sales numbers, market research, and customer behaviours. External factors, like supply chain challenges or weather events, also play a role.

With inventory forecasting tools, you can:

• Optimise your inventory levels 

• Prevent stockout or underselling

• Be ready for seasonal fluctuations 

• Set sales goals for new products

4 Types of Inventory Forecasting Methods

Businesses use different inventory forecasting models to predict future demand and optimise inventory. Understanding these approaches is crucial for effective inventory planning and forecasting strategies.

Here’s the rundown of different types of inventory forecasting methods:

1. Quantitative Forecasting

Quantitative inventory forecasting leans on data such as sales, revenue, financial reports, and digital analytics to predict future sales. 

You really need at least a year of sales data to spot seasonal trends. But the longer you track sales and the more robust your data, the more accurate your predictions become.

The strength of quantitative demand forecasting lies in its reliance on historical data. It helps you spot seasonal trends and recurring annual patterns with confidence. 

Yet, this approach can be challenging for newer companies with limited historical data. Or for those dealing with significant demand fluctuations beyond the regular calendar year.

2. Qualitative Forecasting

Quantitative forecasting uses data for measurable answers. While qualitative forecasting relies on information that can't be quantified for educated guesses.

These methods are primarily used when there is limited data. Such as when a new product enters the market. 

Quantitative methods consider human judgement and expertise to convert qualitative information into forecasting models for quantitative estimates.These insights might come from one or several individuals, within and outside the business. 

Take, for example, the Delphi method. It is a common qualitative approach. A panel of experts generates inventory forecasts with many rounds of questions and feedback. 

Some companies even involve their customers in qualitative forecasting. Market research is one such technique. It gathers data about customer preferences and behaviours. This is done using focus groups, surveys, or interviews.

The sales force also has a vital role as a qualitative inventory forecasting tool. Here, insights come directly from those interacting with consumers on the front lines. It provides unique perspectives on market trends and customer demand.

The qualitative inventory forecasting technique's strength is in the broader range of variables. But, it needs a lot of resources and depends on many future predictions. So, it works best when you don't have much past data. 

So, which method should you use for forecasting inventory demand?

Well, the choice depends on factors like data availability, type of business, and demand patterns. But what works best for most retailers is the balanced mix of qualitative and quantitative information in their inventory forecasting.

3. Trend Inventory Forecasting

This inventory forecasting method analyses past sales patterns and growth data to predict future sales. 

It predicts future customer demand by looking at how a product's demand has changed. This guides the forecast to estimate the quantity of required stock to sell. Understanding customers’ buying patterns is an added incentive of trend forecasting. It helps you assess products' potential and probable cultural shifts. 

Trend forecasting not only reveals product trends but also provides answers to:

• Investment trends as to which products and businesses attract the most investment. 

• Social media buzz about which product is in and which one is out.

• Changes in shipping timelines and geographical impact year over year. 

Armed with these insights, you can refine your inventory and marketing strategy for both peak and off-peak seasons.

If you've got a solid two years of sales data, go ahead and dive into trend forecasting. It helps you make those predictions with a bit more precision.

4. Graphical Forecasting

Graphical forecasting analysis to optimise inventory isn't a separate inventory forecasting type. Instead it’s an application of data from other inventory forecasting methods. 

It uses the same data as trend forecasting but represents it graphically. In the form of a line graph, pie chart or a histogram. There is little chance of overlooking anything in the numbers, as graphical visuals help reveal detailed insights.

Choose this approach if you find it easier to spot patterns visually rather than going through numbers one by one.

In summary, there are four main ways to forecast inventory:

1. Quantitative forecasting: Use past data to predict future inventory needs.

2. Qualitative forecasting: Project future demand using qualitative data. 

3. Trend forecasting: Analyse past trends for future strategies and demand planning.

4. Graphical forecasting: Turn numbers into graphs for easy reading and forecasting.

5 Reasons Why Inventory Forecasting is Important?

Inventory forecasting is the game-changer, deciding whether you lose sales or gain profits. In the retail industry, operational excellence is paramount. And keeping optimal inventory levels through inventory forecasting is integral to it.

This strategic move trims excess stocks, reduces holding costs, and boosts customer satisfaction. Without inventory forecasting, you're simply taking shots in the dark.

So, what is the importance of inventory forecasting for your business? Let's get down to brass tacks of inventory forecasting benefits. 

1. Minimises Stock Out

When popular items go out of stock at critical times, retailers lose revenue. Even worse, you risk losing orders to competitors.

To counter stockouts, many brands over-order, incurring extra costs for faster restocking. Yet, this comes at a capital cost. 

Moreover, running out of stock can hurt profits when fulfilling urgent wholesale orders. Rush charges for quicker supplier turnaround and expedited shipping to meet customer expectations can strain your budget.

Inventory forecasting and planning help anticipate future demand. This reduces the risk of running out when demand is high, ensuring optimal restocking.

2. Avoids Excess Inventory

Surplus inventory is as troublesome as insufficient stock. It causes space issues and complicates item retrieval in warehouses. 

Prolonged storage raises risks of damage, spoilage, theft, or obsolescence with changing customer trends. This often leads to selling at a discount or incurring recycling costs.

Effective inventory management and forecasting avoid these problems, guiding timely replenishment decisions. Moreover, embracing the Just-In-Time model reduces costs, ensuring stock arrives when needed for customer orders. 

It not only enhances cash flow but also frees up funds for other business activities.

3. Efficient Order Fulfilment

With a clear understanding of expected demand, retailers can better optimise their warehouses. 

It streamlines picking and packing, reducing the time it takes to fulfil orders. Quick and accurate order fulfilment contributes to a shorter overall order cycle time.

4. Optimise Production Cycle

Accurately predicting future demand is the key to optimising production cycles. Inventory forecasting enables businesses to manufacture the right quantity of products, meeting customer needs without straining production resources.

This approach allows for a smart allocation of resources such as labour and machinery, avoiding both underutilization and overburdening. 

The result is a streamlined production process, ensuring efficiency and responsiveness to market demands.

5. Set Optimal Reorder Points

Inventory forecasting helps in predicting when stock levels are likely to deplete. By setting an optimal reorder point, eCommerce brands can proactively initiate replenishment orders, minimising stockouts. This prevents delays in order fulfilment and maintains customer satisfaction.

With a defined reorder point, businesses can streamline their retail supply chain processes. This includes smoother communication with suppliers, reducing lead times, and fostering a more efficient and responsive procurement system. 

10 Steps to Choosing the Right Inventory Forecasting Method

Step 1: Evaluate Your Data

Begin by looking at the data you have. Determine if you have sufficient data for quantitative methods or if qualitative approaches might be more appropriate.

Step 2: Consider Demand Variability

Analyse how much your product demand fluctuates. For products with consistent demand, quantitative methods may suffice, while products with unpredictable demand may benefit from qualitative methods.

Step 3: Assess Resources and Expertise

Evaluate your available resources, including technology and personnel expertise. Choose a method that aligns with your team's skills and capabilities.

Step 4: Review Time Horizons

Determine the forecasting time horizon – short-term, medium-term, or long-term. Select a method that suits your business planning cycles.

Step 5: Blend Quantitative and Qualitative Approaches

Recognize the benefits of combining quantitative and qualitative methods. Explore hybrid approaches to enhance the robustness of your forecasts.

Step 6: Test and Iterate

Implement your chosen inventory forecasting technique on a trial basis. Monitor its performance, compare results with actual outcomes, and be ready to iterate based on feedback.

Step 7: Consider Scalability

Choose a method that aligns with your business's growth plans. Ensure scalability to accommodate evolving product ranges and demand.

Step 8: Incorporate Extreme-Need Scenarios

Include extreme-need scenarios in your inventory forecasts to gauge possible demand under exceptional circumstances. This prepares your business for unexpected spikes in demand.

Step 9: Collaborate with Scenario Planning Teams

For major challenges, collaborate with scenario planning teams. Their insights can contribute to developing robust inventory forecasting models that anticipate and address diverse scenarios.

Step 10: Seek Expert Advice if Needed

Consult industry experts or hire a specialised consultant if uncertainty persists. External perspectives can provide valuable insights for informed decision-making.

How Do You Calculate Inventory Forecasts with Inventory Forecasting Formulas

Formulas for forecasting inventory are like building blocks of advanced inventory forecasting models. Calculating them is the key to maintaining optimal stock levels, providing insights into operational efficiency and areas for improvement.

Here’s how to calculate an inventory forecast using some simple inventory metrics:

1. Lead Time Demand

Lead time is the duration your vendor takes to fulfil orders and is critical to anticipating stockouts. In simpler terms, it's the time you need to restock. 

The demand level throughout this duration is referred to as lead time demand. It’s vital to calculate lead time demand, to avoid running out of stock while awaiting new inventory. 

The formula to calculate lead time demand is–

Lead Time Demand = Average Lead Time in Days × Average Daily Sales

Let’s understand this with an example. 

Imagine you operate an online electronics store, and one of your best-selling smartphones has the following details:

Maximum lead time: 18 days

Minimum lead time: 10 days

Maximum daily sales: 15 units

Minimum daily sales: 8 units

Now, let's calculate the lead time demand:

Average lead time = (18 + 10) / 2 = 14 days

Average daily sales = (15 + 8) / 2 = 11.5 units (rounding to the nearest whole unit)

The lead time demand for this smartphone is calculated by:

= 14 x 11.5

= 161 units

This means you should have at least 161 units of this smartphone in stock during the time you await new stock from your supplier. This ensures you can fulfil customer orders without facing inventory shortages during this period.

2. Sales Trends

Sales trends reveal sales patterns over time, offering valuable insights into consumer behaviour. 

This analysis can be conducted at both micro and macro levels. On a small scale, you can analyse the sales of a single product in a few weeks. On a larger scale, observe multiple products over a more extended period, like 30 days, 90 days, or 12 months.

Understanding sales trends provides insights into market conditions and customer buying behaviours. It ensures your online store does not run out of popular or fast-selling products.

Calculate the average daily sales over the past year using this formula—

Average Daily Sales = Total Number of Sales Last Year / 365

3. Safety Stock

Safety stock is the surplus product quantity stored to prevent stockouts. 

Consider this as your backup inventory to ensure you have enough product supply to fulfil customer orders. The safety stock formula helps find the right amount to cover until the next batch of ordered stock arrives.

It is expressed as:

Safety Stock = (Maximum Daily Sales × Maximum Lead Time in Days) − (Average Daily Sales × Average Lead Time in Days)

Where,

Maximum daily usage = The highest number of units sold in a single day

Maximum lead time = The longest duration taken by the vendor to deliver the stock

Average daily usage = The average number of units sold in a day

Average lead time = The average time taken by the vendor to deliver the stock

Going back to the smartphone retailer example. 

Last year, on your busiest day, you sold 20 phones. It usually takes a maximum of 12 days to restock when you run out. Now, let's say, on average, you sell 8 phones every day, and on average, it takes 8 days to get a new shipment in.

The safety stock formula is:

Safety Stock = (Maximum Daily Sales × Maximum Lead Time in Days) − (Average Daily Sales × Average Lead Time in Days)

Substitute the values:

Safety Stock = (20 × 12) − (8 × 8)

Safety Stock = (20 × 12)−( 8 × 8)

Safety Stock = 240 − 64

Safety Stock = 176

So, your safety stock, in this case, would be 176 smartphones.

4. Reorder Point

Reorder Point (ROP) is the inventory threshold signalling when it's time to restock. In other words, when stock falls below this point, it's time to reorder from the supplier to avoid running out.

The reorder point formula is—

Reorder Point (with Safety Stock) = (Average Daily Sales×Lead Time) + Safety Stock

But, if you opt not to include safety stock in your reorder decisions, the formula simplifies to:

Reorder Point (without Safety Stock) = Average Daily Sales × Lead Time

Here's the same example. Our online smartphone retailer sells an average of 15 phones daily. The lead time is 10 days, and the safety stock is 20 phones—

Average Daily Sales: 15 smartphones

Lead Time: 10 days

Safety Stock: 20 smartphones

ROP = (15 × 10) + 20 = 170 smartphones (With safety stock)

ROP=15 × 10 = 150 smartphones (Without safety stock) 

So that the retailer should reorder when the inventory reaches 170 or 150 to avoid stockouts.

5. Average Inventory 

Average inventory is the amount or value of inventory a business has at a given point in time. This helps businesses plan for future inventory needs and assess overall financial health.

Average Inventory = Beginning Inventory + Ending Inventory / 2

If your company has $10,000 in inventory at the beginning of January and $15,000 at the end of January, the average inventory for January is $12,500.

Seasonal Inventory Forecasting 

As an eCommerce retailer, every day is unique. Seasonal demand, right?

Seasonal demand refers to the usual fluctuations in sales over a specific period. 

Consider Australia for instance. Expect high demand for beach umbrellas and sunscreen during summer, December to February. 

Seasonality in eCommerce is driven by factors like traditional holidays such as Christmas, Thanksgiving, Easter, and Halloween. Black Friday, Cyber Monday, Singles’ Day, and end-of-year sales are also crucial shopping periods. 

Furthermore, factors like weather, migration patterns, income availability, and political events also contribute to seasonality.

A solid grasp of seasonal demand is vital for eCommerce brands. Predicting product demand before peak season prepares you for fluctuations in sales volume. 

It enables you to adjust production, procurement, and inventory levels accordingly. Thus, avoiding inventory issues like stockouts and overstocking. In short, it helps you meet your customers' needs when it matters most.

So, here are some tips for seasonal inventory forecasting—

1. Improve seasonal forecasting by ensuring real-time supply chain visibility and interdepartmental collaboration. Choose a unified solution for inventory, financial decisions, and overall business planning.

2. Invest in an advanced inventory management software. It will help you gain real-time insights into inventory and sales. Consistently monitor the entire inventory flow from procurement to fulfilment throughout the season.

3. Enhance efficiency with AI tools and automation. AI solutions remove errors, improve decision-making, and adapt to changing demands.

4. Stay informed about trends and surprises. Unexpected events like viral trends, competitor issues, or external factors can impact inventory. So proactively watch global events and customer sentiments using tools like social listening or Google alerts.

5. Leverage data-driven tools to pinpoint top-selling seasonal items in your niche. Consult industry experts to discover the best-performing seasonal products in your market. 

Top 5 Inventory Forecasting Best Practices

Improving your inventory forecast goes beyond analysing sales figures. A precise forecast means higher profits and lower costs. 

Follow these inventory forecasting best practices for perfecting your forecasting process.

1. Maintain Accurate Records

Remember that historical supply and demand data forms the bedrock of effective forecasting. For precise retail inventory forecasting, keep your records accurate and up-to-date. Use real-time tracking and inventory audits to monitor current stock levels. If discrepancies arise, investigate and learn from them to fine-tune your forecasts.

2. Set a Clear Forecast Period

Recognizing that trends shift and forecasting within a defined time frame is essential to prevent stock shortages. 

Set a specific forecast period that matches your industry's pace and product lifecycle. Be it a month, quarter, or year. 

In fast-evolving industries like tech, opt for shorter forecast periods for timely inventory management decisions.This ensures your stock levels meet demand in the ever-changing market.

3. Consider Inputs from Other Team Members

Improve inventory forecasting by involving team members from different departments. Stakeholders from operations, finance, marketing, and product development bring unique insights.  

For example, warehouse staff, familiar with inventory movements, offer valuable input. Marketers, understanding customer preferences, contribute essential perspectives. Customer service teams, dealing directly with customer behaviour, provide on-the-ground insights. 

Collaborating with these key stakeholders enhances accuracy in predicting inventory needs.

4. Use the Right Software to Support Your Forecasting Needs

Selecting the right software is vital for efficient inventory forecasting. Utilise specialised inventory forecasting tools to streamline the process. Automated forecasting minimises manual effort and human errors, resulting in more accurate forecasts. Choose the solution that best fits your industry and business needs.

5. Plan Ahead

Inventory forecasting thrives on planning. So be sure to allocate dedicated time in your schedule for efficient forecasting.

Stay adaptable and watch for upcoming events or announcements, incorporating them into your forecast early on. This proactive approach enhances the accuracy and responsiveness of your inventory planning.

4 Common Inventory Forecasting Mistakes to Avoid

Mistake #1 Relying on Fragmented Data

Believing good data always equals accurate forecasts is a mistake. 

Retailers often struggle with operational data scattered across different tools, creating information silos. Even with an ERP system, seamlessly integrating all data proves impractical. 

This fragmented approach results in unreliable forecasts. 

To overcome this challenge, having a single source of truth is crucial. It ensures comprehensive and reliable data, leading to improved forecasting accuracy.

Mistake #2 Ignoring Historical Inventory Levels

In the rush of rapid growth, retailers often overlook historical inventory data. They tend to focus more on the impressive sales figures. 

This oversight can be a costly mistake. Depending only on past sales numbers, without considering inventory levels, can cause misinterpretations. 

Let's say there are no recorded sales for a period. Looking only at sales data might lead you to assume it as waning customer interest. But, it could be due to inadequate safety stock or temporary out-of-stock situations. This oversight distorts inventory forecasts, leading to underestimations or overordering, affecting overall inventory accuracy.

Mistake #3 Forecasting All Channels Together

Combining forecasts for different sales channels can lead to inaccurate inventory predictions. It's essential to forecast individual channels separately. 

Analysing channels together assumes total sales equal total demand. But this isn't always accurate. That's because total sales may not align with total demand. 

For example, wholesale orders may not reflect actual demand. As wholesalers might not sell through all ordered inventory. This discrepancy can lead to forecasting errors, affecting inventory planning.

For better inventory forecasting, analyse each channel separately and then combine their needs. This way, you can include specific details, such as wholesale sell-through rates, for more accurate forecasts.

Mistake #4 Ignoring 3PL's Role in Inventory Planner Forecasting

Overlooking the impact of Third-Party Logistics (3PL) on inventory management can lead to forecasting errors. 3PL streamline supply chains, offering real-time visibility, flexible storage, and efficient order fulfilment. Their expertise in managing diverse products and fluctuating demand ensures optimal inventory levels. 

Neglecting these 3PL benefits hampers forecasting precision, cost-effectiveness, and adaptability to market changes. Collaborating with a 3PL is crucial for improving inventory planning and forecasting. 

Top 3 Ways Your 3PL can Help with Inventory Forecasting

1. Demand Forecasting

Effective inventory management starts with accurate demand forecasting. Partnering with a 3PL expert simplifies this task. Using advanced software and data analysis, 3PLs accurately predict customer demand. This way you can optimise your inventory and be well-prepared to meet customer needs.

2. Stock Accuracy

You can visualise a complete picture of inventory levels across the entire supply chain with the help of a reliable 3PL. Their advanced technology maintains accuracy across diverse fulfilment centres and SKUs. Routine cycle counts, conducted daily, weekly, or monthly, guarantee consistent stock precision.

3. Automated Inventory Management

A 3PL with an automated inventory management system gives you a unified view of your stock. It integrates with sales channels and ERP systems and ensures accurate demand forecasting. The automation streamlines order fulfilment, cuts costs, and tracks inventory in real time. 

That’s not it. A top-notch 3PL adjusts inventory globally, responding to shifts in supply or demand. Automating these processes with a 3PL frees you from inventory challenges. So that you focus on key areas like sales and product development.

Conclusion

In conclusion, there's no one-size-fits-all solution for inventory forecasting. It’s an educated guess even with advanced tools. 

While data analysis is crucial, you need a seasoned 3PL for effective inventory management. 

A reliable 3PL minimises stock discrepancies, ensures on-time deliveries, and enhances supply chain visibility for eCommerce businesses. It helps you optimise order fulfilment,  contributing to business growth. 

Considering a 3PL partnership? We're eager to discuss how we can support your company's expansion. Reach out for further insights or explore our comprehensive logistics and fulfilment solutions.

Frequently Asked Questions (FAQs)

Why is inventory forecasting important for businesses?

Inventory forecasting helps businesses anticipate demand, prevent stockouts or overstocking, optimise inventory levels, and enhance overall operational efficiency.

What are the different inventory forecasting methods?

Some common inventory forecasting methods include Quantitative forecasting, Qualitative forecasting, Trend forecasting, Time series analysis, etc. 

How to forecast inventory using software?

Inventory forecasting software uses historical data, algorithms, and sometimes machine learning to analyse patterns and predict future demand. Users input relevant data, and the software generates forecasts to aid inventory planning.

How often should I update my inventory forecasts?

The frequency depends on your industry and product lifecycle. In fast-changing industries, shorter forecast periods may be necessary, while others may opt for monthly or quarterly updates.

How can I improve the accuracy of my inventory forecasts?

Enhance accuracy by incorporating historical data, using advanced forecasting models, staying informed about market trends, and leveraging technology for real-time insights.

What challenges can impact the accuracy of inventory forecasts analysis?

Challenges impacting the accuracy of inventory forecasts include sudden market trends, external events, and data inaccuracies. Regularly reviewing and adjusting forecasts can help mitigate these challenges.