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Chapter 5

Inventory Forecasting Best Practices

Inventory forecasting is an important process to get right but is a bit of a balancing act. You’ll want to purchase enough inventory to keep up with customer demand and reduce the risks of overselling or running out of inventory, while not tying up too much cash within your warehouse due to reordering too early.

In this chapter, we’ll discuss the different inventory forecasting methods you can use, alongside inventory forecasting best practices you should adopt within your business.

Qualitative Inventory Forecasting vs Quantitative Inventory Forecasting

Qualitative inventory forecasting involves predicting sales demand based on macro factors such as the current economic climate, seasonality and political issues such as Brexit or a shutdown of the US government, which can all have an effect on sales.

Although it’s useful to keep an eye on the wider climate and how it may impact your business, you mustn’t rely on qualitative retail forecasts alone.

In combination with qualitative methods,

Quantitative inventory forecasting involves predicting future demand based on historical sales data. An analysis of previous order history can be run for any period of time you deem relevant – whether this is one year, five years or ten years – although it’s widely recognized that the more data you have access to, the more accurate the forecast will be.

While the quantitative method is based on data and scientific study, it won’t be able to give you a complete picture as it doesn’t take into account market conditions, product seasonality or unexpected peaks in demand – for instance, if a celebrity causes a large influx of sales due to wearing or using your product.

This is why it’s recommended to use both qualitative and quantitative inventory forecasting methods in order to gain a more complete picture of your business and future sales demand.

quantitative_inventory_forecasting

Achieving balance in your inventory management

Understanding the Reorder Point Formula

By adopting inventory forecasting best practices, you’ll ensure you always have ‘just enough’ inventory on hand to meet demand, while avoiding tying up too much cash in your warehouse.

As part of the quantitative inventory forecasting method, it’s useful to calculate your reorder point for each product, which represents the level of inventory that should trigger a replenishment order.

Typically, in inventory management software, this reorder point is known as the “Min” as in “Min/Max” inventory.

To calculate what your optimal “Min” number should be, you can use the reorder point formula, which involves the following calculations:

inventory+turnover+ratio

Calculating Your Inventory Turnover Ratio

Your inventory turnover ratio dictates how fast you’re selling your inventory, and thus, how often you need to replenish it.

The common calculation for your inventory turnover ratio is:

cost+of+goods+sold

… which is usually based on 12 months’ worth of data.

As a basic example, if your annual sales totaled $500,000 and you held $75,000 worth of inventory last year, then your inventory turnover ratio would be 6.6.

In other words, you would need to replenish your inventory roughly twice per year.

Quick inventory turnover tip #1:
To eliminate excessive inventory, ensure you have adequate forecasting that is specific to each SKU you use. If you just forecast based on your overall inventory balance, then you may not realize you have too much of one SKU and not enough of another SKU on hand.

Quick inventory turnover tip #2:
Compare your Average Days to Sell Ratio with how long it takes you to place an order for new products from your supplier. If you can get products from your supplier very quickly, then you can have a lower ratio and move closer to a just-in-time inventory model. This makes for great cash flow!

Determining Your Lead Demand & Safety Stock Figures

In order to determine your reorder point, you’ll need to know what your lead demand and safety stock values are, which are represented by the following calculations:

lead+demand Safety_Stock_=_1.65_x_Square_Root_of_Lead_Demand

Lead demand (also called lead time demand) is the projected level of consumer demand for a product between now and the estimated delivery date from your supplier for a new replenishment order.

While lead time is the time it takes from the submission of a purchase order with your supplier to when the items are actually delivered to you.

Many suppliers will provide you with an estimated lead time, however, for the purposes of accurate inventory forecasting, it’s better to calculate your actual lead time. Based on your historical purchase order data, you should see an average length of time that suppliers take to deliver goods to you.

Note: Your lead time will vary for each of your suppliers, and possibly also for each SKU. Set your lead time at either a supplier or a SKU level, or both, to cover all your bases.

Safety stock is the additional inventory you hold in your warehouse to reduce the risk of overselling due to peaks in supply and demand. By using the simple calculation listed above, you’ll be able to hold the optimal level of safety stock – enough that you don’t oversell on fast-moving inventory, but not so much that you’re tying up too much cash in your warehouse.

Establishing Your Reorder Point

Now that you’ve established how quickly you need to replenish your inventory, how long it takes for suppliers to deliver your goods and how much safety stock you need in your warehouse as a buffer, you’ll be able to establish your optimal reorder point using the following calculation:

reorder+point

As explained previously, your reorder point is the minimum quantity of inventory you want to hold in your storeroom or warehouse, so should the item fall below that threshold, you’ll be prompted to buy more inventory from your supplier.

Reordering is a bit of a balancing act as you want enough inventory on hand in order to cover your reorder lead time, without resulting in too much excess inventory from reordering too early.

By using the above calculation, powered by your lead time demand and safety stock figures, you should find that you get the balancing act just right for your business.

Did you know? With Brightpearl’s inventory demand planner, you can:

  • Forecast inventory based on sales forecast, seasonality, inventory levels, supplier lead times and desired days of stock
  • Receive reminder emails when items fall into low stock
  • Setup automatic purchase orders
  • Access inventory aging reports that highlight slow-moving items
  • Access overstock reports that highlight where inventory is too high
  • Run KPI reports for stock turn, sell through, stock cover, PO cover and sales velocity

Further Reading

Ultimate Guide to Inventory Forecasting

by Inventory Planner

Anticipate Future Demand with Quantitative Inventory Optimization

by Brightpearl

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