What is Inventory Forecasting? | Definition, Methods & Formula

Inventory forecasting is a method used to predict inventory levels for a future time period. It also helps keep track of sales and demand so you can better manage your purchase orders. It is a great inventory management tool that can increase your company’s revenue and decrease unnecessary costs.

Benefits of inventory forecasting

Minimizes stockouts

Stockouts mean lost sales revenue. Inventory forecasting helps you avoid this by accurately predicting future demand. With this information, you can better understand when to restock and how many units to order.

Reduces inventory holding costs

Inventory forecasting helps with overall inventory management. It helps with inventory storage space management because you buy only what you need and stock only those products instead of ordering too much. This in turn reduces the unwanted storage space and the costs incurred along with it.

Reduces product waste

Inventory forecasting reveals which items are not selling or which are selling slower. Based on this, you can plan to re-purpose these items or bundle them with better selling products. This frees up warehouse space and increases revenue.

Inventory Forecasting Formula

Inventory forecasting uses factors such as sales history and trends, average lead time, demand, reorder point, and safety stock to predict inventory levels.

To use the inventory forecasting formula, we must do the following:

1. Calculate lead time demand

2. Measure sales trends

3. Set the reorder point

4. Calculate safety stock

Calculating lead time demand

Lead time is the amount of days it takes for your vendor to fulfill your order. To avoid a stockout, you need to predict the product demand during that time. This is called lead time demand. Without this calculation, you run the risk of going out of stock on items while you are waiting for new ones.

Lead time demand = average lead time in days x average daily sales

Lead time demand is calculated by multiplying average lead time in days with average daily sales. The average lead time can be calculated from the amount of time your vendor has taken to deliver the products in the past. Average daily units sold can be derived from the previous sales data by calculating the average amount of products being sold on a daily basis.

Measuring sales trends

A sales trend refers to the increase or decrease in sales over time. Businesses can specify which products to analyze over a set time period. Sales trends are classified into micro and macro. A micro trend focuses on a specific product and lasts a few weeks, while macro trends analyze a range of products over a larger time frame. Sales trends inform you about market conditions and your customers’ buying patterns so that you never encounter stockouts with popular or fast-selling products.

Setting the reorder point

A reorder point (ROP) is the specific level at which your stock needs to be replenished. In other words, it tells you when to place an order so you don’t run out of an item. A static ROP will not help when you’re forecasting. The ROP should be variable based on forecasted sales trends and should be adjusted during every sales season.

ROP = (average daily sales x lead time) + safety stock. 

The ROP is calculated by multiplying your average daily sales with lead time and adding the result with safety stock.

Calculating safety stock

Safety stock is the extra quantity of a product that kept in storage to prevent stockouts. Having excess safety stock can lead to higher holding costs, and having insufficient safety stock results in lost sales. Safety stock serves as insurance against demand fluctuations. This has a couple benefits. Firstly, you save on shipping costs because don’t need vendors to expedite delivery. Secondly, you increase sales revenue by always having stock on hand for customers. Safety stock covers you until your next batch of ordered stock arrives. Using the following formula will help you calculate the optimal amount of safety stock for your business.

Safety stock = (maximum daily sales x maximum lead time in days) – (average daily sales x average lead time in days)

Safety stock is calculated by multiplying maximum daily usage (which is the maximum number of units sold in a single day) with the maximum lead time (which is the longest time it has taken the vendor to deliver the stock), then subtracting the product of average daily usage (which is the average number of units sold in a day) and average lead time (which is the average time taken by the vendor to deliver the stock).

What are the various types of inventory forecasting methods?

All forecasting models draw from upward and downward trends in consumer demand. The accuracy of your model will directly influence profits. Here are some of the most common forecasting techniques for inventory planning and purchasing:

Trend forecasting

Trend forecasting is a method that uses past sales or market growth data to determine the possible sales trends in the future. The upward or downward trend is calculated for the particular product and the demand is forecasted based on the result. Trend data helps determine the future sales and modify your inventory management strategy accordingly.

Graphical forecasting

Converting the previous sales data into a graphical form will help you analyze sales trends more effectively and visually as it is easier to comprehend. The troughs and crests help you identify previous inventory exploration, trends and patterns helping you forecast more easily.

Qualitative forecasting

Qualitative forecasting is adopted when historical data is not useful, relevant, or available. This method involves predicting demand based on current and potential economic demand in the market. Inventory planners repeatedly run this forecast model over a period of time using sales feedback, personal instinct, market research, and panel consensus. Qualitative forecasting works well for new businesses or companies who are looking to introduce a completely unique product to their lineup.

Quantitative forecasting

This forecasting model is usually more accurate because it uses past sales data to predict future demand. Because it relies on previous sales information, this model works best for established businesses. It can be created using the available data from the previous quarter or year. The more data that exists, the more accurate the forecast.

Inventory forecasting is done to calculate your inventory levels and allows you to save up on costs which might be needlessly tied in holding stock. This helps you to optimize your inventory and manage things better.