Business Finance

Guide to Inventory Forecasting

Nov 10, 2022 • 10+ min read
financial forecasting for small business
Table of Contents

      As a small business owner, planning ahead can often make a meaningful difference in the success of your company. When it comes to your company’s inventory in particular, anticipating customer wants and having those products available can give your business a competitive edge that is incredibly valuable. 

      Of course, keeping the right amount of inventory on hand is a delicate balancing act. Order too much product and your business could face a number of problems. The same is true if you order too little. And in either scenario, both inventory shortages and overages have the potential to cost your business time and money. 

      Inventory forecasting is a solution that aims to help businesses avoid these challenges—or at least reduce their impact when they occur. When your business becomes proficient in forecasting, it has the potential to improve profitability, customer satisfaction, and brand loyalty all in one fell swoop.

      What Is Inventory Forecasting?

      Inventory forecasting is a means of predicting how much inventory your business will need on hand for an upcoming period of time (e.g., a month, a quarter, a year). This type of predictive analytics is closely related to demand planning. However, inventory forecasting drills down deeper to deal with data that pertains to the products your company needs to keep in stock to operate at its highest potential.  

      The goal of inventory forecasting is to foresee the upcoming demand for the products your business sells and order enough inventory to fulfill future customer orders. This type of financial forecasting can help you make sure your business is well prepared for the future. 

      An efficient inventory forecasting system should help you avoid shortages of products that could lead to back orders, supply chain shortages, frustrated customers, and lost sales opportunities. At the same time, forecasting should help your company steer clear of challenges like inventory overages, overfilled storage facilities, cashflow crunches, and wasted business capital.

      Types of Inventory Forecasting

      As a small business owner, you may have relied on experience and instincts in the past to help guide your inventory preparations. Such skills are certainly valuable. Yet when you add in data and predictive forecasting tools, there’s a good chance you can improve your outcomes. 

      If you’re ready to set up an inventory forecasting system for your business, there are several options available. You might even decide to mix and match more than one approach. Below are four popular inventory forecasting methods to consider. 

      1. Trend Forecasting

      Trend forecasting is a technique that looks at a combination of past sales data, market behavior, and current trends to predict future inventory needs. Let’s break down these different components into two categories for a deeper look.  

      Past Sales Data

      When examining past sales data, trend forecasting may try to answer questions such as the following: 

      • What types of customers does your company attract? (Sales demographics) 
      • What times of the year do you have higher sales of each product? 
      • Do customers tend to purchase certain types of products at the same time from you? 
      • Do customers buy from you more than once?
      • Do customers buy the same products over and over again, or different products each time? 
      Current Trends and Market Behavior

      This forecasting method also aims to look forward—searching for broad shifts in consumer demand that can help your business stay ahead of the competition. As a result, trend forecasting data analysts may consider:

      • Social media trends (Instagram, TikTok, Facebook, etc.) 
      • Economic changes
      • Regulatory concerns
      • Current investor behaviors
      • Other factors

      Your business can use the information above to plan its inventory orders with more success. The same data can also be useful in your marketing and advertising plans as well.

      2. Graphical Forecasting

      Graphical forecasting is a way of illustrating various types of inventory forecasting data so that it’s easier to understand. With graphical forecasting, you can take the same data that analysts consider in trend forecasting and put it into a chart or graph that shows clear increases and decreases in inventory needs over time. 

      Here’s an example of a graphical forecasting chart for a hypothetical company that experiences higher product demand during the summer season than it does during the rest of the year.

      When you display historical inventory data or future projections as a graph, you get a visual representation of the information you’re trying to convey. This visual component can often provide a clearer picture than you’d get from presenting the same information in a text-only format. 

      3. Quantitative Forecasting

      Quantitative forecasting relies on past historical sales and inventory data to predict future inventory needs. To accomplish this goal, this type of forecast examines your company’s previous demand trends and seasonality shifts. 

      Below is an example of a quantitative forecasting chart for a company that experiences fluctuations in sales—and varying inventory needs as a result.

      Based on the chart above, an analyst for the hypothetical business could easily see that: 

      • Inventory needs fluctuate up and down by around 500 orders per month. 
      • The company has experienced steady sales growth over the past 24 months.

      Because the business can see its number of shipments go up or down by around 500 orders each month, it would make sense to keep additional inventory in stock for months when the business needs it. At the same time, the company can plan ahead for increasing sales growth that puts a higher demand on inventory over time. 

      The more established your business and its product line, the more accurate a quantitative inventory forecast tends to be. You can run this forecasting analysis with at least one year of sales data (to help identify seasonal trends). Yet it’s better to have several years worth of data if you hope to get more reliable results. Unfortunately, this type of inventory forecasting method does not work well for startups and newer businesses. 

      4. Qualitative Forecasting

      For some businesses, quantitative forecasting isn’t available or useful. In such situations, qualitative forecasting can be an acceptable alternative to consider.

      The aim of qualitative forecasting is to predict future inventory demand based on market research. Analysts can perform research with focus groups, study market trends, examine economic demand, and more to make a data-driven assessment regarding your company’s future inventory needs.   

      Accurate qualitative forecasting is a complex process. As a result, it’s a task that typically requires outside support. Most businesses that use this approach as part of their inventory management process hire expert analysts who have experience gathering and interpreting this type of data. 

      Pros and Cons of Inventory Forecasting

      It’s true that introducing an inventory forecasting system into your business can have its benefits. Yet there are some downsides to consider as well. Below are some of the pros and cons that your business might face when it begins inventory forecasting.

      Forecasting can help your business learn from past mistakes.No forecasting method is 100% accurate.
      Understanding inventory needs upfront can help you secure crucial financing in advance (e.g., business loans, lines of credit, etc.). Inventory forecasting can be time-consuming. 
      Efficient forecasting can decrease costs.Inaccurate data can lead to inaccurate results.
      You can better manage your company’s cash flow when you’re making smarter inventory purchasing choices. Some forecasting methods (especially advanced systems) can be expensive to implement.
      Forecasting can help you improve customer satisfaction and brand reputation. 

      Setting Up a Basic Inventory Forecast

      As a business owner, you likely keep a close eye on the inventory needs of your company. Between experience and instinct, you may have even developed a good understanding of your business’ inventory requirements without using a sophisticated inventory forecasting system. 

      However, even the best intuition can be improved upon. And if you hope to scale your business or outsource some of your day-to-day responsibilities, putting an effective inventory forecasting system in place could make a meaningful difference. 

      Here are seven steps that can help you put together a basic inventory forecast when you’re ready.

      1. Select a forecast period. You must decide upfront the length of time your forecast will cover. For example, you might want to forecast how much inventory your business will need for the upcoming year, quarter, or month. On the other hand, some businesses might want to plan ahead for the amount of inventory they’ll need on hand for a busy sales season instead. 

      2. Review historical data. If your business has been around for a while, you can look back at historical orders and inventory needs for a similar period of time in the past. Let’s say you’re trying to forecast inventory for Q4. Finding out the amount of inventory your company moved during Q4 in previous years can be valuable information to build upon. 

      3. Identify trend influences. As you go through historical data, it’s important to separate out any sales behaviors that were out of the norm. For example, did your business run promotions that you don’t plan to repeat? Did your brand receive major media coverage that led to an increase in orders? If any unusual sales spikes or declines occurred, you will likely need to remove those outliers from your calculations. 

      4. Examine your marketing plan. Consider future marketing, advertising, and promotional plans you have in store for your business. 

      5. Consider outside forces. Are there new competitors in the marketplace? Is inflation driving your prices upward (and the number of customer purchases down in response)? Are supply shortages making it difficult to find and keep certain products in stock? 

      6. Create a forecast. Once you’re comfortable with the baseline data you have gathered, you may be ready to create an inventory forecast. Because this process is complex, most companies rely on software to make their inventory forecasts for them. (Inventory forecasting may be part of a more comprehensive enterprise resource planning system or EPR software program, as well.) More established businesses often grow to the point where they can hire external or internal analysts to manage the forecasting process.

      7. Be ready to adjust. No matter how much time and energy you put into forecasting, no prediction is perfect. So, you should be prepared to set strategic inventory reorder points long before your business runs out of stock of high-demand products. This approach empowers you and your team to make changes and re-forecast your company’s changing inventory needs when the need arises. (Tip: You may also want to keep some extra safety stock available to provide a buffer in case you receive more sales than anticipated.) 

      Next Steps

      Making an effort to plan ahead sets your business up for success. Inventory forecasting is important if your company sells goods to consumers. Yet there are other types of planning that are equally important for your business as well (if not even more critical). 

      Cash flow forecasting, for example, is essential for making sure your business has the funds it needs to operate on a day-to-day basis. So, if you don’t already have a system to manage your cash flow in place, consider checking out Lendio’s robust offering of financial forecast tools to get started.

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      About the author
      Michelle Lambright Black

      Michelle Lambright Black is a nationally recognized credit expert with two decades of experience. Founder of—an online community that helps busy moms take control of their credit and finances—Michelle's work has been published thousands of times by FICO, Experian, Forbes, Bankrate, MarketWatch, Parents, U.S. News & World Report, and many more.

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