Inventory forecasting: the small business guide
The secrets to stocking the right products to meet customer demand.
In every business, there are fun and creative parts – whether that’s dreaming up new products or devising out-of-the-box revenue strategies. There are also less glamorous parts. Chances are, inventory forecasting – also known as demand planning– falls into the ‘less glamorous’ category for many retailers.
Yet this back-end business practice is something that every business owner must master if they want to be profitable. “Good inventory management will increase sales, maximise sales potential and reduce costs,” says Marguerite Bell, managing director of Retail Life. “If [something isn’t] in stock, you can’t sell it – or enough of it – and if your supply exceeds demand, you are wasting money.”
A solid inventory forecasting strategy is about having the right amount of stock at the right time— you must optimize for account seasonality, trends, past performance and customer patterns. Planning is key. “It also reduces the volume of slow-moving items that take up time, space, and money [as well as reducing] losses from markdowns and out-of-stock [items],” says Bell.
No matter how big or small your business, there are simple principles that will make inventory forecasting work for you.
"Good inventory management will increase sales, maximise sales potential and reduce costs."
Track inventory
The first – basic – step in creating a good inventory forecast is to record all inventory movements, says Bell, and look at historical data in order to predict the future. This is known as quantitative forecasting.
Six months of historical data is a good start, but a year or more will offer a deeper understanding. “Sales data is king – it is essential that all stock movements in and out are recorded – accurate data is critical to effectively managing [your] inventory.” Once you have precise data, you can monitor sales trends, both from recent weeks and over time, which will help identify patterns.
Invest in software that makes demand planning easy
Unless you’re a statistics wizard, you will most likely need software or digital tools to help you get your head around the data.
For small businesses with limited inventory, basic spreadsheets may work, however, larger businesses should consider more sophisticated software systems. Oracle Netsuite, Acumatica and Syspro offer embedded inventory forecasting tools, machine learning and enterprise resource planning (ERP) that integrates supply chain, accounting and more. Inventory management software is generally known as ‘perpetual inventory’ software as it delivers real-time information about inventory levels.
“There are many inventory planning options on the market that are relatively inexpensive and will provide retailers with all the necessary metrics and reporting tools,” says Bell, adding, “you need a suite of reports to assist in analysing data, be it stock-on-hand, best-sellers or category performance”.
It’s worth noting that many point-of-sale systems, including Square, come equipped with inventory management systems.
Audit regularly for an accurate inventory forecast
While inventory management software aims to automate your replenishment processes as much as possible, it is still important to conduct regular inventory audits.
Inventory forecasting mismatches occur when actual stock levels are different to those reported by your software. This can happen because of ‘shrinkage’, for example, caused by theft, product damage, human error, disorganised stockrooms or returns fraud.
The solution is regular inventory reconciliation, which can be performed by physical stock-checks – comparing reported levels of stock with actual levels, usually at the end of the financial year or the end of the season – or spot checks.
Review suppliers regularly
Auditing stock levels is one thing, but it can also pay to audit suppliers themselves. This will help you monitor which suppliers are consistently late or whether suppliers are regularly supplying incorrect quantities of products. Supply chain problems can spell trouble for your lead times, productivity and forecast.
If you discover suppliers who are regularly causing problems with your supply chain, first attempt to address the issues and if this isn’t possible, consider seeking new suppliers.
Work hand in glove with other departments
“Merchants tend to see ‘buying’ and ‘inventory management’ as two separate functions,” says Bell. But if you’re not on top of your inventory management – and it’s not feeding into your buying decisions – you’re missing an opportunity. “One is creative, and one is technical but only when they work together seamlessly are sales optimised.”
Similarly, it’s important to work closely with different teams within your business when making a demand forecast. The marketing team, for example, may be aware of key advertising campaigns or promotions that could spike demand, while the social media team may be able to pinpoint micro or macro social media trends that will impact sales.
Pay attention to trends
You can’t predict every trend, but it pays to keep your finger on the pulse when it comes to buying behaviours and how consumers are shopping.
From what’s trending on TikTok, to generational shifts (such as Gen Z entering the workforce) and new regulations or legislation that could impact your product or category, make it your business to understand the context and industry in which your business is working. These are all important factors when it comes to inventory forecasting.
Clear out your warehouse
Warehouse management is an important part of forecasting future stock levels; if you’ve worked out that you need a large amount of stock, there’s nothing worse than having no room for it; Bell highlights the need to “clear non-performing stock and aged stock”.
Need to shift excess stock? Consider gift-with-purchase strategies that bundle old or ‘dead’ stock with other products to deliver added value for customers.
Discounts (or discounts to VIP customers only) and reselling to third parties are other options. If you have an oversupply of seasonal products, such as winter knits or summer swimwear, consider promoting these products to customers in the opposite hemisphere. After all, holidaymakers in the UK will be on the lookout for bathers at exactly the same time that we are packing them away for the winter.
Clearing excess stock is cost-effective (reducing warehousing costs), and keeping inventory levels low can assist with forecast accuracy.
Consider seasonal trends that affect demand planning
“Remember, failing to plan is planning to fail,” says Bell. “Plan ahead – identify key events, and marketing activities that will impact sales and stock volumes.”
Look at your marketing calendar for the year and identify seasonal sales periods (like Christmas and EOFY), as well as times of the year that your products traditionally surge in demand (like socks for Father’s Day or pencil cases for back-to-school) and tweak your inventory forecasting accordingly. Good planning is demand-driven.
If you have historical seasonal data, comb through it. “Using [your] gut feeling rather than data to make business decisions,” is one of the biggest mistakes merchants make, says Bell.
Another way to cross-check demand for seasonal products is to look at Google Trends, which shows when people start searching for products.
Consider delays
You can’t control the weather or worldwide shipping issues, but you can have a best- and worst-case scenario plan. “Retailers must focus on what they control – such as known lead times – then ensure that these lead times are built into the order cycle along with contingencies for unknown issues,” says Bell. “COVID-19 taught many retailers that they needed to rely not only on overseas manufacturers and wholesalers but moving forward to include local options to mitigate risk to inventory levels.”
"COVID-19 taught many retailers to rely not only on overseas manufacturers and wholesalers but to also include local options to mitigate risk."
Master inventory forecasting metrics
Even if your business uses automated inventory software, it’s useful to understand— as well as calculate and monitor—a few key demand planning metrics. These include:
Safety stock: The amount of product you need to prevent stock-outs (or out-of-stock situations).
Safety stock = (Maximum number of units sold in a day x maximum lead time for stock replenishment) – (Average daily usage x average lead time in days).
In other words, let’s say that the maximum number of T-shirts you’ve sold in a day is 20 but on average you sell five. When you reorder it takes five days to reorder but has taken up to 10 days in the past.
The T-shirt’s safety stock level is (20 x 10) - (5 x 5) = 175.
Reorder point: The point at which you should replenish.
Reorder point (ROP) = (Number of units used per day x lead time in days) + safety stock level.
If you sell 20 T-shirts a day, the lead time is five days and your safety stock level is three, then your ROP would be (20 x 5) + 3 = 103. So, when you have fewer than 103 T-shirts, it’s time to reorder.
Days to sell inventory (DSI): The average number of days it takes to sell inventory. If your DSI is creeping up this suggests that you’re not managing inventory properly.
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