Inventory is a necessary expense and the foundation of future sales. The amount you spend on inventory is part of your budget because you must come up with the funds to buy wholesale product and raw materials, which in turn bring in revenue so you can replenish the stock you deplete. Inventory forecasting should be based on past sales patterns as well as adjustments for current developments such as aggressive marketing campaigns.
Inventory costs money, and your budget forecasting process should take into account the outlay necessary to have sufficient stock on hand. Suppliers who extend terms, allowing lag time between when you purchase and when you pay, provide you with additional budgeting flexibility because you don't have to treat their invoices as immediate expenses. If you turn around your inventory quickly, moving it before the invoice is due, you even may be able to pay for it directly out of funds you have received from selling it.
When there is ongoing customer demand, inventory levels increase revenue potential. You cannot sell product you don't have, and when you are certain you will be able to sell a specific volume, it is worth incurring debt to make sure you have sufficient stock on hand. Businesses rarely can predict exactly how much they will sell, but many companies experience predictable fluctuations, such as seasonal patterns. The inventory you buy affects budget forecasting by increasing potential for incoming revenue.
Buying too much inventory can negative affect your cash flow and earning potential. If you've invested in inventory that sits on the shelf rather than moving out the door, you've tied up liquid funds that you could be using for day-to-day operating expenses such as rent and payroll. If your inventory is perishable, you risk wasting more than necessary. Unnecessarily high inventory levels result from faulty budget forecasting because you anticipate higher sales than actually occur. In turn, this error in judgment can interfere with achieving income and revenue forecasts by negatively impacting cash flow.
Inventory forecasting also affects budgeting by influencing tax liabilities. When you calculate deductible expenses, you must subtract the difference between inventory levels at the beginning and the end of the tax period because these inventory levels represent assets you have used up in the course of doing business. If you have more inventory at the end of the tax period than you had at the beginning, you must subtract the difference from your deductible expenses, increasing your tax burden. Higher taxes leave you less money for other business purchases such as equipment and advertising.