A Small Business Guide to Inventory Forecasting

Anyone who experienced the early days of COVID-19 remembers the struggle to find toilet paper, and the inevitable follow-up question: Why is this happening, and how do we make sure this never happens again?

“Inventory forecasting is important for small businesses because it ensures they have enough product to fulfill customer orders without spending cash on unnecessary inventory,” said Dan Gray, general manager of Kotn Supply, a Toronto-based custom apparel manufacturer. “Inventory forecasting can mean the difference between profitability and unsold goods.”

Dan Gray, general manager of Kotn Supply

If you’re a small-business leader who has struggled with inventory issues such as supply chain snags, unexpected spikes in consumer demand, and lost revenue due to unsold product, effective inventory forecasting can save you a lot of headaches.

In this article, we’ll take a closer look at inventory forecasting and share some tips on how small businesses can get started with this fortune-changing technology.

Inventory forecasting is a form of demand forecasting that uses historical sales data to predict future demand. These projections can then be used to optimize future inventory levels to meet customer demand. Of course in the real world, things are never this simple, and just because something has been happening a particular way for 10, 20, or even 30 years doesn’t mean that this year will be the same.

One doesn’t have to look far to find examples of situations where demand forecasting failed:

• In 1982, Atari produced somewhere in the neighborhood of 5 million E.T. cartridges for their Atari 2600 system[1], predicting massive holiday sales. At least half of those went unsold, leading in part to the great video game crash of 1983.

• In 1983, an unanticipated spike in demand for Cabbage Patch Kids dolls led to riots at toy stores around the country[2].

• In 2020, COVID-19 led to shortages of everything from toilet paper to hand sanitizer and disinfectant.

Of course, successful inventory forecasting is only half of the battle. For example, Sony had a pretty good idea that its PlayStation 5 system would be in high demand upon its release in late 2020, but consumers are still struggling to get their hands on a PS5 console almost two years later due to a global computer chip shortage[3]. And the baby formula shortage of 2022[4] was caused by the unexpected closure of one of the country’s biggest baby formula plants rather than bad demand forecasting.

Supply chain issues aside, inventory demand forecasting is still incredibly important for businesses of all sizes.

“Inventory forecasting is so important for small businesses,” says Kiakahi Wong, CEO of Kaka’ako Kasuals, a Honolulu-based apparel company. “We miss sales if we don't have enough product, and we can't adequately manage our overhead if we have too much. The careful balance of making sure that we have just enough product to meet demand allows us to maintain our margins so that we can stay in business. Forecasting doesn't have to be a hugely in-depth process for a small business, but it is a vital business practice.”

Kiakahi Wong, CEO of Kaka’ako Kasuals

Now, let’s take a look at how small businesses can get started with inventory forecasting, both with and without purpose-built inventory forecasting software.

Looking for a refresher on general inventory management? Check out this short video.

While inventory forecasting may sound very advanced and complicated, it can also be incredibly simple. For example, if you just look at last winter’s sales numbers on a spreadsheet to get a rough idea of demand for this upcoming winter, you’ve already performed a basic form of inventory forecasting.

“The important thing is just getting started,” says Todd Saunders, CEO of FlooringStores.

“Inventory forecasting starts with effectively measuring your company's purchasing and sales data. Ideally, you want at least a full year's numbers to look at before you start working on forecasting,” Saunders said. “From there, you can get more granular with your purchasing by tracking prices, shipping times, and time between purchase and sale. These will be essential metrics for any reliable inventory forecasting.”

Todd Saunders, CEO of FlooringStores

These are just a few of the additional variables you can use for more accurate inventory forecasting. As you add more variables to your inventory forecasting and gain more experience, you’ll be able to incorporate both quantitative forecasting (that is forecasting based purely on numbers and data) and qualitative forecasting (that is forecasting based on your team’s collective experience, market research, and even “gut” feelings).  On the flipside, the more complex and deep your forecasting gets, the more difficult it becomes to manage using a spreadsheet. This is where inventory forecasting software comes in.

Software helps businesses automate the process of inventory forecasting. It uses artificial intelligence, machine learning, and algorithms to take most of the data entry and guesswork out of inventory forecasting. Rather than being sold as a standalone system, inventory forecasting is typically included as a feature in inventory management software.

If you’re already using inventory management software, you may already have access to an inventory forecasting feature, or it may simply require a software upgrade. Talk to your inventory management software vendor to determine if you already have access to inventory forecasting, and to get a tutorial on using the feature.

How the inventory forecasting feature works will vary from one inventory management system to another, but here’s a brief overview of what inventory forecasting looks like in an inventory management software:

Inventory planning in NetSuite (Source)

Here are a few common inventory forecasting features, along with tips for how you can use them to help your business grow:

• Inventory projections. This feature uses historical data along with artificial intelligence to help project future inventory levels. This helps businesses figure out which items they’ll have in ample supply and which items they might need to find a new vendor for. The more historical data you have, the more accurate these projections will be, so don’t wait to get started.

• Order planning. This feature helps businesses determine exactly when to order more inventory and how much to order. For more predictable items, you can even set up recurring orders to be transmitted automatically by your software.

• Inventory alerts. No matter how carefully you plan and how fine-tuned your inventory forecasting software is, there will still be unexpected inventory shortfalls and surpluses. In these situations, inventory alerts can help businesses take action—such as finding an alternate inventory source or selling off excess inventory—before the problem snowballs. If you’re in charge of inventory, you can have these alerts sent to your mobile phone so that you receive them as soon as possible.

It’s important to remember that even if you’re using software-backed inventory forecasting, you still need the data to power your system and improve forecast accuracy.

“The best thing smaller businesses can do to get started with inventory forecasting is to simply commit, begin, and let the data build,” says Stephen Light, CEO of Nolah Mattress, a San Antonio-based mattress company.

“The longer you collect data, the sharper its accuracy will be, so small businesses should do a bit of research, choose the inventory management software that suits their needs, and allow the data to start building. Years down the line, they'll be very thankful they did.”

Stephen Light, CEO of Nolah Mattress

In this article, we looked at the importance of inventory forecasting for small businesses, along with tips on how to get started both with and without software. And if you take one thing away from this article, it should be to get started as soon as you can.“While it can feel like an overwhelming task for a smaller business to begin, building and maintaining a data-driven inventory management strategy can reap many benefits, including increased cost savings and customer satisfaction, disruption-proofing, and stronger supplier relationships, among many others,” says Light.

Here are a few next steps you can take, with options for businesses of different sizes and growth stage:

• Begin collecting historical data (monthly and annual sales numbers, vendor prices, lead time data, etc.) in a spreadsheet to inform future projections.

• Select an inventory management system and begin using it as soon as possible so the software’s AI can start learning from your data.

• If you already have an inventory management system, check with your vendor to make sure you’re taking full advantage of the software’s forecasting features (for example, setting up inventory alerts and automatic reorders).

Once you’re ready to explore inventory management systems that best suit your business needs, we have you covered. Our 2022 Category Leaders in Inventory Management features 15 top-rated inventory management products based on thousands of verified user reviews (full methodology here).

GetApp’s 2022 Category Leaders in Inventory Management (Source)