Excess inventory may also result from forecasts that underestimate actual demand. If a distributor underestimates customer demand and experiences a stockout, he or she may panic and override the computer system's recommendations for product replenishment. Any part of this unusually large quantity not actually needed to protect customer service is excess inventory. It is money tied up in an asset that is not producing a return on investment. In order to prevent excess inventory, forecasts of future demand must be as accurate as possible.
Most systems forecast future demand with a formula that utilizes past sales or usage history.
Often, the formula using past usage or sales is supplemented by a trending factor that compensates for recent increases or decreases in usage. Forecasting future demand solely on past usage history is like predicting weather from a windowless room using a stack of old newspapers. As your customer's work schedule is developed, their system automatically alerts your system when they will need a specific quantity of each of the products you supply. If their work schedule changes, your system automatically learns how the changes will affect the delivery of these items. Let's look at an example.