How to Select the Right Inventory Forecasting Models
- Long term and Short Term Inventory Forecasting Models
For wholesalers and distributors of durable goods products, inventory forecasting is especially important as it is the foundation upon which all company plans are built in terms of markets and revenue projections. Management would be a simple matter if business was not in a continual state of motion, the pace of which has quickened in recent years.
Inventory forecasting models are critical elements of the forecasting process as accuracy can drastically influence business profitability. It is becoming increasingly important and necessary for business to predict their future demand in terms of inventory availability, sales assumptions, costs and profits.
Assessing the actual value of future sales is crucial as it directly affects future carrying costs and profits, so the prediction of future sales is the logical starting point of all business planning, including inventory purchasing. There are 2 main inventory forecasting models to consider for enhancing inventory forecasting accuracy:
- Quantitative Forecasting – This forecasting approach is a mathematical model based on historical data. It involves using past sales data to predict future demand for goods. Data sets can go back decades or can be run for the last calendar year, however the more data available, the more accurate picture of historical demand will be attained. While it may provide a basis for forecasting, demand can be unpredictable based on variable market conditions or product seasonality. Unexpected peaks in demand can result in stock outages and quiet periods may result in costly excess stock, which can build up carrying costs resulting in diminishing profits.
- Qualitative Forecasting – This method is less precise, and involves predicting demand based on less measurable factors such as market forces, economic demand and potential demand. Qualitative forecasting methods could be considered an art mastered by inventory planners over years of practice. Inventory forecasting techniques are inseparable from current stock review and reorder methods, and there are two broad models for inventory monitoring.
Depending on the industry and the unique businesses inventory turnover ratios, there are 2 different models for monitoring inventory and replenishment:
- Continuous Review – Stock is reviewed on a continuous basis, and a certain amount of stock is reordered once levels have dropped below a certain level known as the reorder point. Having the right reorder point will allow for supplier variability and should be supported by a safety stock level “safety net” to ensure service level rates are maintained. Companies with fast moving products are highly encouraged to invest into tools that support continuous inventory review.
- Periodic Review – Stock levels across all storage points are monitored at set periods, and replacement stock is ordered. This usually results in higher inventory levels as stock needs to be ordered in sufficient quantity to reach the next review date. This model requires more available cash flow and working capital to maintain and the risk of overstocking and under stocking items is greater. Businesses with slower inventory turnover can leverage this model successfully with the help of inventory optimization solutions that provide inventory alerts when actions need to be taken to avoid undesirable stocking situations.
Long term and Short Term Inventory Forecasting Models
Inventory planners need to evaluate and monitor both long-term and short-term influencers when it comes to demand forecasting. For instance in a short run forecast, seasonal demand patterns are of great importance to inventory planners. Seasonality typically will influence a period of three months, six months or one year an these data points should help guide planners when making inventory replenishment planning and procurement activities.
Long term demand forecasting models are helpful when it comes to making larger capital planning decisions. These models provide information for making major strategic decisions and demand pattern data from long term data sets can help a company forecast for end of life products and new product introductions to a growing industry.
Inventory forecasting cannot be regarded in isolation; it is an integral part of any business operation and all key stakeholders from management and finance to operations and IT should be involved. All processes need to be integrated to ensure the business is as efficient as possible.
Inventory forecasting software such as EazyStock can help organizations to become more versatile by integrating advanced inventory management capabilities into everyday business processes.
Now you have learned the basics about the 2 different forecasting models (quantitative and qualitative forecasting) as well as about the different approaches for monitoring the inventory (continuous and periodic review). However, this is just the theoretical part. For implementing these processes in practice this is much more complex. Are you interested in further information? Then download this white paper to learn how to improve demand forecasting accuracy: