Everything You Need to Know About Inventory Forecasting

In a world of complex supply chains, rapidly changing sales trends, and the continued expansion of communication channels, correctly predicting what you will need to meet consumer demand can be quite a daunting task. 

While the ability to collect and dissect a diverse range of data has given merchants deep insights into their operations, an eclectic mix of variables can impact even the most informed plans for the future. As a result, like many things in business, an accurate inventory forecast can best be viewed as both a piece of science and a work of art. 

At SkuNexus, inventory management software is a core component of the systems we develop for our clients, and we understand the challenges inventory planning can present for even the most seasoned eCommerce companies. We also know the profound impact that getting it right can have across a merchant’s entire business.

Here, let’s take a deep dive into inventory forecasting (aka demand planning). We will cover the fundamentals, go over benefits and methods, and discuss what software can do to help put you on the road to optimized inventory management.

What is Inventory Forecasting?

First things first. 

Inventory forecasting is the practice of estimating the amount of stock needed to meet future customer demand. Retailers, both online and brick-and-mortar, use it to determine the appropriate time and quantity to restock their inventory. This process involves analyzing information from various sources including, but not limited to, past sales history, market trends, and customer behavior. 

While forecasting involves some level of uncertainty, the more historical data available, the more precise the prediction. However, because no forecast is certain, many businesses adopt inventory management software with flexible demand planning capabilities to help adapt to changing situations.

5 Useful Metrics/KPIs to Monitor

Inventory management KPIs contain a wealth of actionable data, and knowing and understanding key metrics is crucial for forecasting demand and managing replenishment.

1. Forecast Accuracy
Formula: 1 – [(Actual Sales – Forecast Sales) / Actual sales] 
— Forecast accuracy (FA) measures the degree to which demand predictions match actual sales. High forecast accuracy indicates a better alignment of operational costs with demand, leading to increased profits. 

The standard for good or acceptable FA may vary depending on the product and business circumstances. For example, a new product without sales history will have a lower acceptable FA compared to products with a long-established sales history. However, for seasonal products, the forecast accuracy percentages may be lower due to weather-related fluctuations. FA may be calculated as frequently as needed or as feasible given the pace of business cycles.

2, Forecast Error
Formula: Actual sales - Forecast sales
— Comparing predicted sales with actual sales results gives insight into whether goals are being met by individual departments or teams. This basic metric can be reported on a regular basis for any period of time (weekly, monthly, quarterly, etc.) — frequency of reporting depends on the nature of the product or service and the urgency of decision making. Forecast error data is essential for an inventory planner to evaluate the accuracy of their predictions and for sales managers to monitor performance and provide guidance.

3. Lead Time
Formula: Order Processing Time + Production Time + Delivery Time
— Lead time is a fundamental element of both inventory and supply chain management. Inaccurate forecasts can lead to stockouts, wasted warehouse space and unmet customer orders. Conversely, accurate forecasting here can help merchants optimize inventory levels, streamline warehouse operations, and fulfill orders.

4. Inventory Turnover Rate
Formula: COGS (Cost of Goods Sold)/Average inventory
— Inventory Turnover Rate will help inform decisions about stock levels and/or pricing. The two methods of computing ITR are not equivalent, however, and this must be understood. The COGS ratio is considered more accurate as it does not incorporate sales markups on top of cost. Regardless of method used, a low ITR can denote poor sales or excess inventory whereas a high ITR, while preferable if due to strong sales, can also mean pricing levels are too low and need adjustment.

5. Reorder Point
Formula: (Daily Sales Velocity) × (Lead Time in Days) + Safety Stock
— Reorder points are set as thresholds or trigger points to prompt action when inventory reaches a specific level. These points simplify the decision-making process of when to reorder inventory and can easily be automated - inventory management software that provides real-time information makes it easy to place new orders when inventory drops to the reorder point level.

Determining the appropriate reorder points can be more complex, however, as it depends on various variables used in the calculation process. 

9 Benefits of Inventory Planning

By keeping just the right amount of inventory, businesses are able to enjoy a plethora of advantages. They include:

1. Improved decision-making: The market research and careful analysis involved in optimized inventory forecasting spans across the entire business. It can help online retailers make informed decisions about much more than just inventory costs and future sales.
2. Proactive ordering: With accurate forecasting, businesses can proactively order finished goods instead of waiting until stock is depleted.
3. Reduced stockouts/overstocks: Inventory forecasting helps businesses avoid costly stockouts and overstocks by ensuring they have the right inventory levels at the right time.
4. Higher customer satisfaction: Few things disappoint customers more than learning items they want to buy are out-of-stock. 
5. Increased efficiency: A coherent forecasting technique helps businesses streamline their ordering process and reduce lead times.
6. Reduced carrying costs: This directly follows the elimination of overstocking. By forecasting demand and ordering goods accordingly, businesses can reduce carry of inventory costs associated with holding too much stock.
7. Better supplier relationships: Inventory forecasting can improve relationships with suppliers by providing them with a clear picture of your future demand. A symbiotic relationship between merchants and vendors helps all parties.
8. Improved cash flow: By optimizing inventory levels and reducing carrying costs, a business can free up capital to use elsewhere. 
9. Easier Inventory Control: Fewer inventory items on-hand are easier to control and organize, by definition, and this reduces the labor needed to perform various warehouse processes. The increased ability to track inventory as it makes its way through the supply chain is an added bonus here.

4 Inventory Forecasting Methods

A handful of general methods, both technical and fundamental, exist to help merchants create proprietary forecasting models.

1. Trend Forecasting: Looks at historical sales data to identify patterns and trends in demand. Once these trends have been identified, they can be used to predict future demand for a particular product or group of products.
2. Qualitative Forecasting: Demand forecasts based on expert opinions or judgments about future demand for a product or group of products. This can include input from salespeople, managers, and other stakeholders within a business.
3. Quantitative Forecasting: Uses mathematical and statistical models to make predictions about future demand. These models may be based on historical data, market research, or other information.
4. Seasonality Forecasting: Takes into account predictable seasonal patterns which bring increased demand for certain products during certain times of the year (e.g. “back-to-school” clothes shopping, springtime for construction raw materials, etc.)

It's important to note that most forecasting methodologies use a combination of these different methods, and which one(s) to use depends on the nature of the product and the industry. Each one has its own strengths and weaknesses, and a good forecast is the result of a careful selection of methodologies and integration.

Inventory Forecasting Software

Increasingly critical to any eCommerce merchant’s success, inventory management software with predictive analytics can give them a broad array of weapons for gauging future demand and procuring the inventory to meet it. In general, look for a platform that provides the following:

1. Advanced Notifications: By using a demand algorithm to determine the estimated date a product will run out, the system can send alerts to the merchant when it's time to order more. Additionally, automated alerts can signal when stock levels reach a minimum trigger. Software may also allow merchants to link products they sell with the suppliers they buy from, and take into account factors such as lead times, minimum order quantities, and other procurement details when providing reorder recommendations and alerts.
2. Automated Purchase Orders: By constantly updating values like sales velocity, reorder quantities, and forecasted reorder dates, software helps ensure that your products are always in stock. It should automatically generate purchase orders based on these factors, as well as lead times and seasonality, all in real-time. Replenishment recommendations may take into account sales velocity, vendor lead time, anticipated growth percentage and estimated runout dates by automatically creating purchase orders when necessary.
3. Pinpointing of Overstocked Goods: Identifying opportunities to cut dead weight inventory is vital to reducing overhead costs. By offering, for example, liquidation recommendations for slow-moving SKUs with high inventory values, a system can free up cash, staff time and shelf space for products that drive profit.
4. Historical Data: Beyond raw numbers, a visual representation of products that are consistently contributing to, and hurting, your profitability can be a powerful tool. It allows you to see year-over-year growth per product and compare and contrast SKU performance (both quantity and revenue) across selected sales channels. This is essential in making informed decisions on which products to invest in and which to discontinue.
5. Trend Identification: Management software is invaluable for sifting through data and picking up patterns that the human mind might not see. Particularly for businesses with a large product catalog, this functionality can spot proverbial diamonds in the rough, and alert you to increase stock in items showing steadily increased demand.

As has been stated for millennia, the only constant in life is change, and the speed with which that change takes place has never been faster. Technology has made certain of that. By embracing that technology, however, eCommerce merchants can venture confidently into the future.

At SkuNexus, we aim to both help companies solve current issues and to empower them with the ability to conquer what may come. If you would like to learn more about what our management software solutions can do for your business, please schedule a demo.

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