One of the most difficult aspects of running a business—particularly within the e-commerce space—involves inventory management. It’s a tricky task to determine how much inventory you should maintain at any given time.
As a business owner, you must walk a fine tightrope to avoid having too much or too little inventory, since either scenario could have dire consequences. Excess inventory reduces your available cash flow and takes up costly warehouse space, whereas inadequate inventory puts you at risk of running out of stock or missing out on potential cost efficiencies.
To excel and scale properly, your inventory must exist within the Goldilocks zone, meaning you’re not overstocked or understocked—you’re just right. But how do you balance optimal supply with customer demand?
This is where inventory forecasting comes in.
What Is Inventory Forecasting?
At its core, inventory forecasting is all about finding equilibrium—the point where supply meets demand. In such a state, there’s neither a surplus nor a shortage of goods.
But since product supply and product demand are in constant flux, and it’s both impossible and impractical to field the perfect number, the inventory equilibrium isn’t so much a point as a boundary range. So long as you stay within its general parameters, you should have enough stock on hand to weather potential market shocks.
Inventory forecasting is sometimes referred to as demand forecasting since it involves estimating the demand customers will have for a particular good over a defined period of time. Knowing how, when, and why demand fluctuates allows companies to maintain an optimal inventory balance, thus preventing the potential negative consequences of having a surplus or being understocked.
Typically, forecasting helps companies manage two factors:
- Order cost variance – Bulk ordering tends to lower the price per unit cost for an item, while smaller orders raise the price per unit cost.
- Supplier lead times – Companies must consider the time it takes to order more of an item from a supplier and then receive that delivery.
Accounting for these factors will help you maintain the proper inventory stream, and keep an optimal inventory safety stock.
To understand how to forecast inventory effectively, you must first consider certain variables within your forecasting equation.
- Forecast period – This is the selected window of time used to determine the inventory quantities you must order. You’ll need to take a look at your inventory turnover rate, how quickly you sell the products, and the manufacturing production cycle.
- Seasonality of demand – Practically every business undergoes seasonal fluctuations or trends that either increase or decrease demands. Sellers must leverage historical data to identify when peaks and lulls are most likely to occur, and then stock their inventory accordingly.
- Maximum stock level – Your maximum stock level is the given point that should not be exceeded when inventory planning, which can be calculated using several inventory accounting methods. Per Accounting Tools, “This stock level is based on a calculation of the cost of storage, standard order quantities, and the risk of inventory becoming obsolete or spoiling over time. Another issue may be a strict limitation on storage space, as may be the case for refrigerated or frozen goods.”
- Perishability of inventory – If your goods are non-perishable, they can sit on your shelves for a longer period of time without losing significant value (at least, until they become obsolete). With perishable goods, such as food and beverage, there’s more risk involved with overstocking.
- Reorder point – This figure represents the figurative canary in the coal mine. When inventory hits this level, it signals that it’s time to replenish your stock before it can be fully depleted. This figure is calculated by multiplying your lead times by average daily sales, and then adding the safety stock.
Inventory Forecasting Methods
Every inventory forecasting method leverages upward and downward consumer demand trends to calculate a product’s Goldilocks zone. Because your model’s forecast accuracy can have a direct impact on profits, it’s essential that you carefully select the methodology that’s most applicable to your specific industry and product.
There are 4 common models that most businesses will utilize:
#1 Trend Forecasting
This methodology uses historical data—specifically, past sales and market growth—to identify any type of potential sales trend. Once identified, you can then extrapolate to predict what is likely to occur in the future. According to Small Business Chronicle, trend forecasting “…uses time-series data, which is data where the numerical value is known over different points in time. Typically, this numerical data is plotted on a graph, with the horizontal x-axis being used to plot time, such as the year, and the y-data being used to plot the information you are trying to predict, such as sales amounts or number of people.”
When studying the numbers, several different patterns may emerge, including:
- Constant patterns
- Linear patterns
- Exponential patterns
- Polynomial patterns
#2 Graphical Forecasting
Using this method, you can take historical sales data and convert it into a graphical representation. Charting allows you to visualize sales trends and gain a temporal perspective of the natural ebbs and flows of the business. Both troughs and crests within the graphs represent the ideal maximum and minimum inventory boundaries. By identifying these boundaries, you’ll be able to forecast more easily into the future.
#3 Qualitative Forecasting
Do you lack historical sales data? For newer companies or businesses launching a new product, this can be an issue. However, with qualitative forecasting, you can make up for that lack of data by going directly to the source—i.e., your customers. This method predicts inventory demand according to current and potential economic demand, as well as market forces.
Gathering this data requires an amalgamation of in-depth market research, focus groups, sales feedback, and panel consensus. Once collated, this data can then be used to build an inventory forecasting model.
#4 Quantitative Forecasting
This mathematical model provides the most accurate demand forecasting since it relies on previous sales data to better predict future customer demand. As a result, quantitative forecasting is ideal for established businesses that experience fairly predictable growth.
Data can be used from the previous quarter, the previous calendar year, or several previous calendar years. Whatever you choose, the more data, the better. That said, this method may have some shortfalls since it’s difficult to account for product seasonality or market variability.
Outsourcing Inventory Forecasting to a Fulfillment Partner
Inventory forecasting can be a difficult process, especially when selling new products or entering new markets. This is why an increasing number of businesses turn to logistics providers to handle order fulfillment and storage.
Logistics providers assist businesses that need help with supply chain management, providing services including:
- Inventory storage and fulfillment
- Transportation sourcing
- Shipping receiving and distribution
- Picking and packing
As experts in all things inventory management, these specialized outsourcers boast years of experience helping companies similar to your own. This frees you from having to worry about inventory forecasting, allowing you to focus on what you do best.
Other benefits of outsourcing inventory forecasting to a partner include:
- Free up resources – Outsourcing creates economies of scale within your business. Instead of having to invest in infrastructure or dedicate manpower toward management and logistics, those resources can be directed to areas where there’s greater demand.
- Streamline and automate your inventory forecasting – A partner’s inventory management platform is capable of integrating with your POS system. This allows you to automate inventory forecasting and leverage machine learning to continuously optimize inventory projections. Aside from tracking inventory, they can also forecast ideal stock while accounting for your specific goals and needs.
- Minimize your costs – By minimizing storage costs and losses associated with overstocking, you can save money. POS integrations ensure that you can update your stock numbers in real-time, providing better projections and reducing risk.
- Increase brand loyalty – When you outsource inventory management, you boost product availability and improve order accuracy. This ensures that products are readily available when consumers want to purchase them. And satisfied customers are loyal customers.
- Discover trends – Gaining accurate insights and leveraging inventory demand forecasting allows you to identify trends in customer purchasing behavior. This knowledge makes it possible to maintain the ideal inventory level for a variety of different products.
- Optimize product groupings – Inventory management systems help you determine how to optimally group your inventory, whether it’s for preparing bulk orders, bundling products, or merging products across several sales channels.
Flowspace—Helping You Scale the Right Way
A growing business can’t afford to have improper inventory levels. Understocking can lead to customer dissatisfaction, and overstocking can cause waste. To effectively scale your business and experience financial success, you need to find that perfect balance—that Goldilocks zone. Inventory forecasting can help you do just that.
But what if you lack the expertise, the resources, or the time to focus on inventory management and forecasting?
That’s where Flowspace comes in. We’re experts in all things e-commerce fulfillment, and our software platform offers an inventory management system that helps you keep up with customer demand.
Help your business flow into that Goldilocks zone, with Flowspace. Get a quote today.