Whether you own a physical retail store or run an online store, inventory forecasting can help you:
Meet customer orders on time.
Utilize resources – storage space, staff, and budget – in an optimal way.
Always be prepared for an increase in product demand.
Achieve your financial targets in a steady and predictable way.
And it’s easy to see how. If you’re unable to maintain sufficient inventory levels, you may lose out on potential sales. Similarly, if you overstock products, your cash will be tied up, which negatively affects your liquidity.
The solution is to find the right balance between optimizing inventory levels and cash flow management. This is what inventory forecasting is all about.
In this post, we’ll explain what inventory forecasting is and why it’s essential in the context of e-commerce order fulfillment.
What Is Inventory Forecasting?
Inventory forecasting involves measuring and maintaining stock levels required to complete customer orders. You do this by estimating how many products you’re likely to sell over a specific time period. Managers use historical sales data – taking into account future promotional campaigns and various external factors – to accurately predict optimal inventory levels.
Here are some of the key benefits of inventory forecasting for e-commerce businesses:
Need to store less inventory. If you store your products in large volumes in a warehousing facility, they’ll stay there for a long time without bringing in any money. By estimating how much inventory you’ll require over a known time period, you can improve inventory accounting, maximize your cash flow, and have more capital on hand to re-invest in your business (on marketing, for example).
Fewer stockouts. Inventory forecasting stops you from having to worry about running out of stock since you can complete customer orders as soon as they’re received. In other words, you’ll be able to minimize lead time effectively.
Less manual work, more automation. Inventory forecasting can help you minimize costs related to hiring workers and acquiring storage space. Why? Because you’ll have more prediction power and can quickly adapt to changing demands. It allows you to predict labor needs better and automate the reordering process. As a result, you’ll always have a better idea of what’s coming your way and be in a position to reduce inventory holding costs.
Better product cycles. Accurate inventory forecasting allows you to better manage inventory throughout the supply chain. Knowing the manufacturer’s lead times, your warehousing facility’s receiving schedules, and the exact inventory levels you’ll need of each item to place a new purchase order, you can improve productivity and better understand product cycles. Utilizing inventory forecasting eliminates guesswork and lets you optimize production timelines and shipments.
Now that we have a better understanding of inventory forecasting let’s take a closer look at how you can forecast inventory and its role in the financial success of your online business.
How to Forecast Inventory
There’s a lot that goes into effective inventory forecasting. You have to stay on top of trends, determine when to reorder products, and much more. Here, we’ll dig deeper into the different factors you need to consider to forecast inventory.
Decide on a Forecast Period
A forecast period is the period of time it takes to calculate the inventory levels you’ll need to order accurately. Selecting the right duration depends on your manufacturer or supplier’s production cycles and your inventory turnover rate.
For instance, if you sell out more of your inventory quickly, you’ll be able to repurchase and restock new inventory more frequently. So, an e-commerce company that sells apparel might have a smaller forecast period as compared to a company that sells furniture.
Study Seasonal and Buying Trends
In the context of order fulfillment, seasonal trends mean a change in product demand over a specific time period. For instance, a company selling sports gear may witness a rise in sales in the summer months. The business can then use this information to increase their inventory levels in the weeks leading up to summer and slow down as the season comes to an end.
To take things further, here are a few questions to ask yourself that’ll help you better analyze consumer buying trends:
Do buyers often purchase the same products from you?
Are buyers purchasing multiple products from you every time they place an order?
If so, which items do people typically buy together?
As you attract new buyers, you can use this information to predict repeat purchases. Taking note of which products people buy together will allow you to better understand consumer buying behavior. It will help you figure out which products you should promote together in marketing campaigns. This information will also give you useful insights into how a single SKU can affect demand for another one.
Determine Your Reorder Point
As you complete customer orders, your inventory levels start to fall. And when they reach a certain threshold, they’ll have to be restocked. The reorder point is the number at which you send a new purchase order to the manufacturer.
It’s not a “red alert” that you’re going to run out of stock soon but acts as a strategic indicator that takes into account mutliple factors. More specifically, the reorder point is calculated by adding:
The manufacturer’s lead time for delivering stock to your warehouse.
Your warehousing facility or fulfillment services’ stock receiving turnaround time.
The number of safety stock days in case there’s a sudden rise in order demands or if delays happen on the manufacturer’s end.
The sum of the above mentioned days will be multiplied by your average stock demand per day to give you the reorder point. Once an SKU’s inventory level falls below this reorder point, you should send a notification to inform your inventory planner that it’s time to generate a purchase order.
Calculate Lead Time and Safety Stock
Lead time is the time between placing a purchase order and when you receive the stock at your warehouse. You’ll need to ensure that you have adequate supply during this time. Lead time demand is the estimated level of sales that happen during a purchase order’s lead time i.e., the amount of inventory you forecast will sell before the purchase order arrives.
Here’s the formula for calculating your lead time demand:
Lead Time Demand = Lead Time (Days) * Predicted Daily Number of Sales
Safety stock prevents your business from going out-of-stock before you can restock it. If you’re low on inventory, you won’t be able to fulfill customer orders and could potentially risk losing them altogether. Maintaining safety stock levels allows you to meet orders promptly.
Here’s how you can measure safety stock:
Safety Stock = Lead Time Demand * 50%
Inventory Forecasting Best Practices
Here are some inventory forecasting best practices to bear in mind to make sure you’re always on top of inventory management.
Involve key stakeholders
Inventory forecasting involves input from different departments. Your team’s inventory planner should take suggestions from all key stakeholders (including marketing, operations, product development, and finance teams) into account. Every department will provide different input that can be used together to forecast inventory levels accurately.
Take notes to improve future planning
Monitoring order volume isn’t the best way to manage inventory levels. You also need to take note of several factors and events that may be causing changes in order demand. For example, this may include new marketing offers and promotional campaigns, upcoming holidays, and other such events that can cause an increase or decrease in sales or changes in the production cycle.
It’s important to make sure that demand forecasting doesn’t take unpredictable events (like a sudden rise in demand for tents due to a natural disaster) into consideration. These types of activities should not be a part of your forecast as they’re unlikely to repeat.
Use inventory management software
Restocking inventory in a timely manner may seem like a daunting task. One way to overcome this is by investing in inventory management software for your business. Start by integrating all of your data from different sales channels onto a single platform.
You need to ensure that the inventory management software you use offers the features you’ll need to handle the size of your business, its various processes, and the types of products you sell.
Inventory Forecasting Models and Techniques
Let’s take a look at some of the commonly used inventory forecasting models and techniques.
#1: Quantitative Forecasting
Quantitative forecasting utilizes past sales data to predict future sales. The longer the company has been in business, the better its analysis will be. At minimum, you’ll need a year’s worth of data. That is the minimum amount of data needed to identify seasonal trends. A dataset that spans many years will give you more accurate estimations and insight into sales patterns.
#2: Qualitative Forecasting
Qualitative forecasting relies less on the data from your customer’s order history and more on external factors such as environmental forces, market intelligence, and economic demand. Because this is a specialized form of inventory forecasting, it shouldn’t be done by someone who lacks experience.
#3: Inventory Forecasting Tools
If you handle your order fulfillment, you should opt for an inventory management solution that comes with forecasting tools. It will allow you to:
Track your inventory levels and the number of items sold per day.
Generate reports to find which products sell more frequently.
Develop a better understanding of your company’s performance.
Some inventory forecasting tools also enable you to visualize data, perform advanced analytics, and run inventory reports on sales and inventory metrics. This way, you can connect the upstream activities of buying and producing to the downstream activities of sales and order demand.
#4: Enlist a 3PL
As your business expands and you have to meet larger volumes of customer orders, it may become difficult for you to stay on top of inventory planning. Most e-commerce businesses hire a third-party logistics (3PL) company to handle their order fulfillment. Doing so gets them access to the resources and labor to help them optimize inventory forecasting.
Inventory management is a continuous process that involves paying attention to multiple factors that can potentially affect sales. By carefully planning and developing a solid understanding of different forecasting techniques, you’ll be able to better manage your inventory without running out of stock or facing overstocking scenarios.