How to select the right inventory forecasting models
- The importance of inventory forecasting
- Inventory forecasting methods
- Quantitative forecasting
- Qualitative forecasting
- Which demand forecasting model is best?
- Long and short-term inventory forecasting models
The importance of inventory forecasting
Whether you’re a manufacturer, wholesaler or retailer, inventory forecasting is a critical process for your business. Get it wrong and there can be drastic implications. For example, if there’s too much working capital tied up in stock, you could face cashflow problems. Whilst stocking too little inventory can lead to stockouts, unhappy customers and a damaged reputation.
Predicting future sales or customer orders is the logical starting point of all business planning activity, including inventory purchasing. If you can accurately forecast future demand, you can optimise your inventory purchasing processes and reduce carrying costs, both of which ultimately affect your bottom line.
Inventory forecasting methods
There are two top level inventory forecasting methods to consider when calculating demand: the quantitative inventory forecasting model and qualitative inventory forecasting model. In general, qualitative forecasting is based on subjective opinions and insights, whereas quantitative forecasting is more focused on the use of historical demand data to predict the future.
Quantitative forecasting takes historical demand data and combines it with a mathematical formula to determine future performance. It often involves using past sales figures to predict future demand. Data sets can go back decades or can be run for the last calendar year. However, the more data available, the more accurate the forecast.
Quantitative inventory forecasting relies on having sufficient, good quality data to make a reasonable assessment. And when data is not available, such as for new businesses or products, it’s simply not possible to use this method from day one.
Qualitative forecasting techniques are far more subjective than their quantitative counterparts, relying on educated deductions rather than number crunching. With qualitative forecasting, demand is forecast based on expert knowledge and experience of how the market works. This could come from one key person or from opinions and insights – both internally and externally to the business.
Qualitative forecasting methods could be considered an art mastered by inventory planners over years of practice. In addition, qualitative forecasting might include predicting the impact of a new sales promotion, estimating the effect a new technology may have on the marketplace or considering the influence of social trends on future buying habits.
Qualitative inventory forecasting, however, relies on having expert knowledge of the marketplace and there’s always a risk that too much expertise lies with one person.
Which demand forecasting model is best?
Smart inventory planners may choose to use both qualitative and quantitative forecasting techniques to calculate future demand, for a more well-rounded perspective. For example, manufacturers, Outdoor BBQs Ltd, might use historical data to set their base demand forecast for their gas BBQ range (a quantitative form of forecasting). But if consumer research shows that electric BBQs will increase in popularity in the coming year, they may adjust the forecast and inventory levels accordingly, using a qualitative approach.
Long and short-term inventory forecasting models
Businesses should take time to model both long and short-term inventory demand forecasts, as both are necessary for different reasons:
Short-term demand forecasts
Short-term forecasts e.g up to a year-long, should provide data for inventory planning, replenishment and procurement activities.
Short-term forecasts will be subject to many variables, including demand fluctuations, such as seasonality, and supplier lead time volatility. Both can affect re-order points and safety stock levels. Forecasts therefore need to be detailed and constantly reviewed and updated, to take account of constant change.
Long-term demand forecasts
Long-term demand forecasting is helpful to provide data for major strategic and investment decisions.
When focusing on inventory strategies, it can help businesses with product planning, such as forecasting the end of some lines, or predicting new market trends that require new ideas and innovation. Such decisions can impact production scheduling which often needs to be planned many months ahead of products getting to market.
Consequently, effective long-term forecasting requires more than a snapshot of current events but also a deep knowledge of the marketplace.
If you find inventory forecasting a challenge, contact the EazyStock team today. Our demand forecasting software gives you advanced inventory management capabilities that you can utilise to improve the day-to-day running of your business – fast.