Inventory modeling isn’t just for accountants—it’s a crucial driver of working capital, cash flow, and profitability in every solid financial model.
Whether you’re forecasting for a manufacturer, retailer, or distributor, understanding how inventory behaves over time helps you optimize liquidity, plan ahead, and avoid surprises.
So, how do you model inventories effectively? Here are 3 proven approaches I recommend using in financial models:
🔹 1. Scenario-Based Approach
This is the fastest method—and a great one for sensitivity analysis.
👉 Start with your COGS forecast
👉 Use Days Inventory Outstanding (DIO) to estimate future inventory balances
👉 Apply scenario logic to see how changes in DIO affect your inventory and cash flow
👉 For example, model what happens if DIO increases or decreases by 5% or 10%
📌 Best for: Liquidity analysis, short-term planning, and exploring how operational changes impact cash reserves.
🔹 2. Component-Based Approach
Need more details? This method breaks inventory into key components:
- Raw Materials
- Work in Progress (WIP)
- Finished Goods
👉 Use separate Days on Hand (DOH) for each component
👉 Calculate inventory balances based on your COGS forecast
👉 Adjust each component based on lead times, production cycles, or supply chain trends
📌 Best for: Manufacturing or supply chain-heavy businesses with multi-stage inventory needs.
🔹 3. Roll-Forward Method (Ideal for Short-Term Forecasting)
If you’re building a short-term or monthly forecast, this is the method to use.
👉 Start with the beginning inventory balance
👉 Add new purchases
👉 Subtract COGS and write-downs (e.g., obsolescence or shrinkage)
👉 Arrive at the ending inventory balance
This method ensures you can reconcile against financial statements and understand the timing of inventory purchases and usage.
📌 Best for: Retail, wholesale, or businesses with detailed tracking and monthly updates.
💬 My Take?
There’s no one-size-fits-all. You might even use a hybrid approach, depending on your business complexity and available data.
But whatever method you choose, what matters is this:
✅ You understand the operational drivers
✅ You’re clear on the timing of cash impacts
✅ You link inventory forecasts to working capital and the cash flow statement
📥 Want this Inventory Forecast Model in Excel?
I’ve packaged these 3 approaches into a downloadable Excel file with pre-built logic and examples.
