How Inventory Forecasting Works

Inventory forecasting is an important feature for all businesses that sell physical goods. Inventory management systems can predict future stock levels by looking at the past sales of each item in your inventory. The main goal of forecasting is to maximize the number of orders you fill, while minimizing the number of items you stock.

The idea is easy: supply the number of goods that will fill demand. But, it’s almost impossible to determine the exact number of goods to equal demand. Using a system to forecast will increase your firm’s ability to estimate future sales. As a result, you can reduce stock shortages or overstocks, as well as their costs. 

Even though the inventory software will do most of the work for you, it is important to understand where the numbers come from. This can provide a frame of reference for are correctly entering data into your system.

Here are some simple formulas from AllBusiness.com that will help you better understand forecasting:

Lead Time

The time from when you place a purchase order with a supplier to when it reaches your door is called lead time. It is important to make sure you have at least enough supply to last during this time. Always make sure that your inventory levels will satisfy your customer demand.

Lead time demand is the projected level of sales during a purchase order’s lead time (i.e. the amount of stock you predict will sell before your order arrives).

Here is an easy formula to calculate your lead time demand:

Lead time demand = lead time (usually in days) x forecasted daily unit sales.

Safety Stock

Safety stock protects your company from running out of stock before you are able to replenish it. There are many complications that can arise during this time period. For example, a supplier delaying a delivery or an unexpected increase in sales. In order to prepare for situations like these, you need to keep some extra inventory on hand.

A shortage of inventory means your customers won’t receive their orders, and as a result may take their business elsewhere. Maintaining minimum levels of stock will ensure you keep a good reputation with your customers.

A simple solution to determine safety stock is:

Safety stock = lead time demand x 50%

Reorder Point

A critical aspect of managing your inventory is determining when you need to reorder stock. This process may be tricky, depending on the complexity of your inventory. The reorder point will forecast when you should replenish your inventory stock before reaching your safety stock. This calculation will keep your inventory at appropriate levels and mitigate the risk of stock shortages.

The reorder point, therefore, should be calculated as follows:

Reorder point = lead time demand + safety stock

Keeping these calculations and concepts in mind, your business will be able to mitigate the chances of shorting inventory and accumulating overstock.

Interested in learning more about inventory management? Find out how Clear Spider can help you.