Demand Forecasting and Its Importance

Whether at an individual level or for businesses and governments, human beings have always wanted to know the future.

Soothsayers and astrologers, tarot card readers, palmists – all have been held in awe for centuries.

Things are only slightly different today.

Businesses want to know the future but have more scientific methods to make predictions.

Businesses want to know how much they can expect to sell in a particular period so that they can plan their purchases and production accordingly.

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Demand forecasting or sales forecasting is the process of estimating customer demand for a certain time period in the future – say the coming 6 months.

Reliable ERP software like Tranquil offers a pretty accurate forecast after taking into account historical data, seasonal trends, market conditions, and the general state of the economy among other things.

If it is implemented correctly, businesses get invaluable information about how they can expect to perform in the present market and others.

This enables managers to make better decisions about pricing, market potential, and business growth strategies.

When you don’t leverage the technology that allows you to get accurate forecasts you may end up making poor decisions regarding your products in your target markets.

It may even impact your supply chain management, customer satisfaction, inventory carrying cost, and eventually, profitability.

The Scope of Inventory Demand Forecasting

This depends on the area the company is operating in currently, as well as the proposed area in the future.

For example, if a company sells its goods or services only locally, forecasts can be made at the local level.

However, if it operates in several countries, forecasting can be done at the international level.

The scope can be determined after taking into account the expense and time involved as compared to the benefit offered by the inventory demand forecasting.

In other words, the cost of making the forecast should be properly balanced by the benefits received in the form of additional sales.

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What is the Importance of Demand Forecasting?

The need for demand forecasting depends on individual companies, and there are several reasons it is important:

• Sales forecasting offers businesses the information that helps them to plan, set goals, and budget their expenses. Knowing your possible future sales, you can develop a procurement strategy to make sure that you are able to meet the demands for your products in the immediate future.
• You can improve your inventory turnover rate, decrease carrying costs, and optimize your inventory levels more efficiently with demand forecasting in supply chain management.
• You will be able to easily identify and resolve any problems in the sales funnel well in advance, ensuring steady business performance for the entire period. Overstocking and understocking are both not good for business. The former leads to unnecessary expenses, and the latter could mean not meeting customer demands.

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• With reliable demand forecasts, you get insights into the imminent cash flow, allowing you to budget vendor payments and other operational expenses more accurately. It will also enable you to continue to invest in business growth.
• Knowing how much your sale is likely to be for a certain period can help you to make the requisite decisions about hiring more employees, and assigning the necessary resources for ensuring smooth operations in peak periods.
• Demand forecasting helps in informed decision-making, and brings down the risk associated with business activities. Companies that produce goods in huge quantities find forecasting even more valuable as it helps them to strategize and achieve business goals quicker.
• Good forecasts aid the company to plan things like production, capacity, and facility layout in a proper fashion. It also helps in inventory management and process selection.

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• It offers useful data that helps in making decisions about capital investment and expansion for the company. It also provides a way to frame optimal advertising and pricing strategies.
• Having a clear picture about profit analysis and cost budgets is essential to exercise tighter control on your business activities, and demand forecasting helps you do exactly that.
• With demand forecasting, you can ensure more stable operations through crafting optimal business policies that can weather economic fluctuations, whether seasonal or cyclical.

This gives a pretty clear picture about the importance of demand forecasting.

Demand Forecasting Methods

Undoubtedly, demand forecasting is an extremely valuable business tool.

However, it is imperative that you know the types of demand forecasting so that you can choose the one that will be suitable for your business.

You also need to know how to implement it to derive maximum benefits.

Most of the techniques for forecasting demand belong to one of three main categories:

Qualitative Forecasting

Qualitative techniques are employed when the data available is sparse – which is usually the case with new businesses, or newly launched products.

Here, you can consider expert opinions, comparative analyses, and market research to arrive at the estimated quantity of demand.

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Time Series Analysis

When you have sufficient historical data for the business or a specific product, you can use this technique.

The time series analysis technique can be used to forecast demands when distinct trends can be seen.

This method is helpful in identifying cyclical patterns, important trends in sales, and seasonal demand fluctuations.

It works very effectively for established businesses.

Causal Models

The causal forecast model is an advanced and complicated tool for forecasting.

It utilizes definite information about the relationships between different factors that affect market demand.

Examples of these variables are competitors, socioeconomic factors, and economic factors.

Here too, it is important to have historical data, to develop a precise causal model prediction.

A company can build a causal model forecast by considering factors like their marketing activities and budget, demand for the products they sell in their location, historical sales data, competing stores in the same locality, demography, and even unemployment rates.

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Types of Demand Forecasting

Let us now examine the different types of demand forecasting so that you can determine which one is most suitable for your business.

Passive Demand Forecasting

When your company is stable and your growth strategy is conservative, you can perform passive demand forecasting.

In this method, historical data is extrapolated in a simple manner, and with nominal assumptions.

This type of forecasting is rare, and usually preferred by small, locally operating businesses.

Active Demand Forecasting

If your company’s growth and expansion plans are aggressive, and you want to diversify and scale up your operations, active demand forecasting is a suitable method.

It considers your growth plans, expansion of your product portfolio, external factors like the economy and market trends, and your competitors’ activities to make a forecast.

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Short-Term Demand Forecasting

As the name suggests, it is executed for periods of 3 to 12 months – a shorter time period where business is concerned.

In this approach, seasonal demand trends, and the impact of strategic decisions on consumer demand are taken into account.

Medium to Long-Term Demand Forecasting

In this method of forecasting, the prediction is normally made for periods ranging from 12 to 24 months, or even up to 36 or 48 months.

To effectively plan finances, capacity, capital expenditure, marketing, and sales, you need long-term forecasts.

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External Macro Level Demand Forecasting

In this type of forecasting, you basically deal with the wider market movements that depend on the macroeconomic ecosystem.

It is made to assess the strategic goals of the company, like risk mitigation, tapping into new markets, expanding the product portfolio, adapting technology, and so on.

Internal Business Level Demand Forecasting

When companies concentrate on their internal business operations like manufacturing, sales, finance, production, etc., it is called internal business level forecasting.

This takes care of annual sales forecast, cash flow, net profit, and the cost of goods sold, among other things.

Factors Influencing Demand Forecasting

Multiple factors impact the demand forecasting process. Let us examine the most common and important ones:

• Existing economic conditions – per-capita income, purchase patterns of consumers, prices of raw materials, employment levels, saving and investment habits.
• Current industry conditions – the level of business concentration, competing business
• Condition of the organization at present – the quality of products, price, plant capacity, marketing, distribution policies
• Predominant market conditions – change in customer preferences and expectations, population demographics, types of families
• Psychological conditions like change in fashion, attitude, beliefs, culture, perception
• Competitive conditions like the number of businesses offering similar products
• Export import policies of government, facilities, terms, and conditions

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Important Sales Forecasting Metrics

Now that you’ve got the basics of your demand forecast, it’s time to know what metrics you need to track for the forecast period

• Product Lead Time – the time it takes from when you place the purchase order till the products are ready for sale
• Sales period – the number of months each product will sell
• Cost per Purchase – the percentage of the product cost that is paid when you place a purchase order
• Days Payable – number of days available to pay the balance inventory cost
• Stock levels – the quantity of the product you need to stock as per the forecast
• Purchase Cost – the amount you need to purchase goods or raw materials

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Forecasting Seasonality and Other Trends

By seasonality, we refer to the demand fluctuations that take place periodically and at particular times – like festivals, and holidays.

Trends differ in that they can happen at any time, signifying a general behavioural shift.

Trend projection is valuable in making future demand predictions, along with historical sales data.

Both trends and seasonality are important when you have to make sales forecast.

It helps in the accurate planning of operations, improving marketing campaigns, and inventory management tactics.

Most retailers hire additional staff in the expectation of more sales as people buy gifts for friends and family.

It’s not enough to merely stock up more – you need to have the workforce to handle it as well.

Shipping companies hire extra package handlers and drivers, for example.

Even with the extra employees, you may find it difficult to serve all your customers.

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Sales forecasting is not a one-time activity, but an ongoing one.

Ideally, it should:

• Drive demand actively through optimization of sales channels, customer experiences, product portfolios, and the like.
• Work to decrease errors and bias with time
• Leverage sophisticated analytics to develop a smart, agile response to consumer demand.

Conclusion

Sales or demand forecasting is an excellent method of anticipating what consumers want from your company in the future so that you can ensure sufficient inventory and resources for meeting that demand. Forecasting also allows you to reduce expenses on inventory and other operations without compromising on quality or efficiency. It ensures you have what it takes to successfully handle demand surges when they happen.

Tranquil is a robust solution with flexible and effective modules that will help you manage your inventory and production more efficiently. Schedule a demo with us to learn how Tranquil can benefit your business. Our representatives will walk you through the software and answer any queries you may have.