04 Dec 2024 12 MIN READ
Non-obvious strategies for profit growth: the impact of AI demand forecasting on a company’s P&L
Modern businesses deal with huge amounts of data that have complex and often non-obvious relationships between different industries and areas of the company’s activities. Therefore, traditional analytical tools are becoming less and less effective. Without the latest approaches to analysis and forecasting, it is difficult to understand the underlying factors that affect profitability and where the causes of potential losses lie. Solutions using AI-based algorithms come to the rescue, more accurately recognizing hidden correlations and allowing a better understanding of the connections between large data flows. Such solutions automate routine tasks and give businesses a new level of operational efficiency. AI algorithms free up resources for strategic planning, which has a positive impact on management decisions and expenses. As a result, the company receives improved sales profitability, supply chain optimization, reduced storage costs, workforce planning, etc., as well as the ability to quickly respond to market changes. All this ultimately affects the P&L indicators. Therefore, we suggest sorting out how exactly accurate AI forecasting can optimize costs and increase the profitability of your business.
Why is forecasting accuracy a strategic challenge not only for Supply Chain but also for other parts of your business?
Consulting company Grand View Research predicts that the global AI demand forecasting market size will grow by 10.3% every year.
Forecasting is usually associated with Supply Chain, as accurate forecasts require a clear understanding of future needs for optimal inventory, production, and delivery management. However, this key function has much broader business implications and extends beyond the supply chain, impacting the company’s P&L.
Forecasting accuracy is essential for finance departments, as it allows for better control and planning of expenses and revenues, as well as minimizing risks associated with market volatility:
- Budgeting and Spending Planning: Accurate demand and sales forecasts provide the finance department with clear guidelines for more informed planning. Knowing which products or services will be in greatest demand and in what volumes allows finance specialists to more effectively allocate resources between departments and projects, adapting the budget to actual needs. This helps avoid unnecessary spending or insufficient funds to support priority areas. By aligning forecasts with the company’s budget decisions, the finance department gets a clear picture of the business’ needs, which helps to plan expenses rationally.
- Capital Investments: Accurate demand forecasts give the business an understanding of when additional resources may be needed to meet growing demand. This allows it to more effectively plan investments in new equipment, capacity expansions, or other capital projects. This way, the business has the data to avoid the risks of underinvestment or overspending.
- Cash Flow Stability: The cash flow of a business depends on the ability to anticipate seasonal fluctuations in demand or changes in supply costs. When forecasts are accurate, the finance department can plan payments and investments to avoid cash flow gaps and maintain cash flow stability.
- Minimizing financial risks: Accuracy in forecasts helps reduce risks that arise from sudden changes in the market, such as a shortage of raw materials or a sudden drop in demand. The finance department, thanks to forecasts, can create reserves or plan alternative sources of income in case of changes.
For example, according to Pro Consulting, due to the crisis in Sri Lanka and complicated logistics as a result of russia’s full-scale invasion of Ukraine in 2022, prices for unpackaged tea leaves have increased significantly – by more than 40%. Using modern AI solutions for forecasting, tea packaging companies in Ukraine can predict the growth or decline in demand in advance, as well as select optimal suppliers of raw materials. This helps make strategic decisions on creating reserves, reorienting imports to more stable markets, or concluding long-term contracts with suppliers at fixed prices. In addition, with the help of accurate forecasts, a company can develop strategies for diversifying sources or finding an alternative. For example, replacing some of the raw materials with local suppliers, which will reduce the risks of supply chain disruptions. For example, domestic companies can quickly introduce new positions of herbal, phyto and medicinal teas grown in Ukraine. Forecasting will help meet the trendy consumer demand for a healthy lifestyle or strengthening the immune system in the pre-winter period. This example shows the logical connection between demand forecasting, the market’s dependence on imports, crisis conditions and the ability of companies to adapt their business processes.
- Impact on profit and loss (P&L): Accurate forecasting of demand and expenses helps to avoid excess production and reduces the cost of storing unsold goods. This has a positive effect on profitability indicators, reduces operating costs and ensures stable profits.
In addition to financial departments, the marketing department can significantly improve the development of its promotional strategies. For example, the SMART Demand Forecast solution has a scenario forecasting functionality that allows businesses to assess how demand will change under different conditions. For example, the solution helps to model what will happen if you reduce the price, launch or change promotion, or invest more in marketing activities. After all, without additional stimulation of demand, it will be possible to fulfill the sales plan by only 70%. This approach helps the company choose the most profitable scenario that best meets business goals. Based on this, the company can make decisions on the feasibility of additional expenses or investments and adapt its resources and strategies in advance.
In addition, demand forecasting affects the work of cross-functional teams, because the results of such calculations affect human resource planning. Thanks to accurate forecasts, the HR department can plan the recruitment and attraction of employees for periods of expected demand growth. This allows you to avoid both a personnel shortage and an excess of human resources, which has a positive effect on work efficiency and cost optimization.
And if you are still convinced that forecasting only concerns the Supply Chain and bypasses other departments of your company, we suggest you visually understand how forecasting accuracy has a direct impact on P&L indicators. In the table below, we analyzed the key components of income and expenses, in particular: revenue, cost of goods, operating expenses, marketing and administrative expenses, and taxes. Each item contains both planned and actual indicators, supplemented by comments on the reasons
for deviations. The last column shows the share of influence of accurate forecasting on these indicators, which could ensure a more accurate match between forecasts and actual results.
| P&L COMPONENTS | PLANNED INDICATORS | COMMENTS ON PLANNED INDICATORS | ACTUAL INDICATORS | COMMENTS ON ACTUAL INDICATORS | FORECASTING ACCURACY IMPACT |
|---|---|---|---|---|---|
| Income | 1,100,000.00 | Profit was planned based on standard monthly demand without taking into account major market changes or additional promotions. | 1,200,000.00 | An unplanned promotional campaign lowered product prices, which resulted in a temporary increase in revenue, but this increase did not offset the additional expenses. | 100% impact |
| Other income | 50,000.00 | A small income from the sale of services or goods of another category that is not the core business of the company was planned. | 55,000.00 | “A slight increase in additional income from accessory sales due to increased customer traffic due to the promotion. The slight deviation is explained by less stable service revenue, which depends on current market demand.” | Partial impact |
| Cost of goods sold | 400,000.00 | The cost of goods was calculated taking into account stable prices for materials and the expected production volume. | 442,000.00 | “Due to increased demand for products during the promotion, production costs increased, as the company was forced to purchase additional materials at higher prices. Increased demand led to higher production costs, which demonstrates the dependence of cost on demand.” | 100% impact |
| Operating expenses | 180,000.00 | Operating expenses were planned based on fixed expenses for office, warehouse space and basic needs of the company. | 215,000.00 | Operating expenses exceeded the planned ones due to additional warehousing and logistics costs during the promotion. Due to increased demand for products, some costs increased. This shows that operating expenses can also be variable depending on demand. | 100% impact |
| Labor expenses | 120,000.00 | Salary expenses were planned in accordance with the current company staffing and payment schedule. | 127,000.00 | Wages increased due to the need to attract additional personnel and the overtime required to process orders. | 100% impact |
| Marketing expenses | 40,000.00 | Marketing expenses included only basic advertising expenses without additional campaigns. | 70,000.00 | Marketing expenses increased significantly due to unplanned advertising expenses for the promotion, which led to an increase in expenses overall. | 100% impact |
| Administrative expenses | 20,000.00 | Administrative expenses for current needs were projected to be minimal. | 25,000.00 | Administrative expenses increased slightly due to additional costs to support the workflow. | 100% impact |
| Depreciation | 30,000.00 | Depreciation was planned based on the gradual wear and tear of fixed assets. | 30,000.00 | Depreciation remained at the planned level, unchanged. | Minimal impact |
| Interest expense | 20,000.00 | Loan servicing expenses were stable and projected in accordance with current conditions. | 21,000.00 | A slight increase in interest expense related to a delay in settlements due to high cash turnover during the promotion. | Partial impact |
| Taxes | 40,000.00 | Expected tax expenses calculated at a standard rate based on projected revenues. | 45,000.00 | Tax liabilities increased as higher revenues entail a higher tax burden. | 100% impact |
| Net Profit | 300,000.00 | Projected net income taking into account planned revenues and expenses without significant promotions or changes. | 280,000.00 | Net income decreased as higher expenses on the promotion and product discounts offset revenue from increased sales, preventing the company from achieving the planned profit level. | 100% impact |
As we can see, the actual net income was lower than planned due to unexpected expenses, market changes and unplanned marketing campaigns, as well as logistics costs. Operating expenses and the cost of goods had a significant impact on the final financial result. The ability to quickly obtain an accurate demand forecast could significantly reduce the risk of deviations, as shown in the last column. After all, this would provide better predictability and greater efficiency in the distribution of expenses, which would increase the company’s profitability.
So, if you want to have additional leverage over your company’s P&L indicators, SMART Demand Forecast will provide these opportunities for you with its following benefits:
Automation and speed of forecast updates
AI algorithms allow for quick analysis of large volumes of data, enabling prompt update of supply recommendations, reduction of lost sales and avoidance of freezing of funds in stock.
Consideration of long-term and short-term factors
The solution takes into account both long-term (economic, social and cultural) and short-term factors (temporary promotions, special offers, etc.). This ensures multi-level forecasting and accurate tailored forecasts for business.
Flexibility in forecasting at different levels of aggregation
The system allows forecasting at different levels of aggregation – from national to individual regions, cities and locations. This ensures accurate adaptation of forecasts to the specifics of each level for business needs. In addition, the system supports analysis on different time scales – from short-term forecasts for operational planning to long-term ones for strategic decisions.
Customer behavior analysis
The solution analyzes sales data for each store separately, taking into account individual trends and consumer preferences.
Avoiding shortages and surpluses
Accurate forecasts for each store help avoid product shortages and reduce surpluses, thus optimizing warehouse stocks
Taking into account unique location specifics
The solution’s algorithms adapt forecasts to individual store characteristics (area, traffic, demand), helping to build the most efficient business processes.
Supply chain optimization
Thanks to accurate forecasting for each point, companies can organize the supply chain more efficiently. This helps reduce transportation costs and ensures continuous supply of exactly those products that are most needed in a particular store.
Building a single intelligent IT ecosystem
SMART Demand Forecast is a modern solution based on Microsoft technologies that uses AI algorithms for highly accurate forecasting. Integration with other software products of the Microsoft ecosystem ensures data integrity and consistency of key business processes. This approach helps to create a powerful IT ecosystem that adapts to the specific needs of the company and provides ample opportunities for its development and scaling.
A McKinsey & Company study found that forecasting using AI algorithms can reduce supply chain management errors by 20-50%. At the same time, there is a 65% reduction in lost sales and unavailability of goods. In addition, storage costs can be reduced by 5-10%, and administrative costs by 25-40%. See for yourself how forecasting accuracy can affect your business profits. To do this, use special calculator from SMART business. This tool will help you estimate how much money your company will receive by increasing forecasting accuracy using SMART Demand Forecast.
Don’t miss the opportunity to improve your strategic planning and increase future profitability now:
