A sales forecast is a month-by-month financial projection of the amount of revenue that a business expects to generate from the sales of its products or services. It is not simply a quantitative calculation, but also involves detailed consideration of various external market issues affecting the business. Forecasting therefore is both an art and a science.
If we could forecast the future accurately, most of us would spend our lives at a racetrack or casino rather than at work. But forecasting the future is something we all have to do as business owners - either to set internal goals, to obtain additional financing and for other reasons. Forecasting is, however, one of the most difficult and frustrating things that we have to do and few things cause as much anguish and soul searching as sales forecasts.
So, for a start, forget trying to predict the future and focus on using “informed judgment”. Many attempts at forecasting fail because those involved, from sales reps. to business owners, don’t have the detailed knowledge of their market, their competitors, their customers and potential customers that is essential for making good estimates. They are less than fully informed when they make their judgment of what will happen – and that’s a failure of work and effort, not of technique.
We also forget that we can only control some of the things that have an impact on our forecasts, for example, the number of dealers we approach, the effectiveness of our promotional tools and our price strategy. There are others factors which directly affect the odds of our success but which are beyond our control. Some are known and can be reflected in the assumptions on which are forecasts are based, for example the price of crude oil, low pay scales for offshore labour. But there are others to which we can only react, for example an unexpected outbreak of SARS.
Sales Forecast - Common Mistakes
The most common mistakes are that we overestimate how much we can sell and how quickly we can sell it. Avoiding those mistakes is hard enough when estimating how much more our existing customers will buy of the products they currently use. Adding any “new” dimension just adds complexity.
Forecasting increased sales to current customers should be easy. We either increase the volume of existing products, start selling them products they don’t currently buy and / or increase prices. But if the account managers don’t have the skill - or don’t make the effort - to get as much information about, for example, what is happening in the customer’s own business and how that affects our offering to them, we will be trying to forecast with less than detailed knowledge. So, we can’t make informed judgments - fertile ground for overestimating what can be sold.
What happens if, for example, we’re going to start selling an existing product in a new geographic market? If our competitors already offer a product in that region / province / country, how much of our sales will come from the market share we’ll take away from them and how much will come from the continuing growth of the market? To begin, we must understand how our product quality, lead times and prices compare with our competitor’s and how much it will cost to get our message heard over their promotional “noise”. We can do some simple, inexpensive research to gain the detailed knowledge required to answer those questions.
When it comes to taking market share away from competitors, we have to make 2 sales. Firstly convince the customer to stop buying from our competitors and then convince them to buy our product - which is untested in this marketplace. But for most business owners, who are natural optimists and driven, type ‘A” personalities, it is not difficult to underestimate how long this will take!
Estimating the sales that will come just from market growth may seem easy by comparison. All we have to do is to convince the remaining distribution channels to sell our widget - make 1 sale instead of two (always assuming our competitors have left some distributors for us). But estimating how long our new distributors will need to ramp up requires information to help us assess how effective the distributors will be. We also want our share of the market to grow at least as quickly as the market itself. The future market growth rate can be forecast using the actual growth rate for the last 2 or 3 years (either as is, or adjusted upwards or downwards). The rate at which we grow depends on how good a Marketing plan we have. Developing an effective Marketing plan requires informed judgment. Anything less, combined with that optimistic approach of the entrepreneur, will, once again, result in overestimates.
Forecasting future sales is a crucial part of setting up and running a business as well as an essential part of business planning. The future is always uncertain but you need to be able to make credible, evidence-based projections in order to help you plan your business strategy.
Why Some Forecasts Are Better Than Others
Excel Data Analysis - Forecasting
Why Forecast Sales?
Forecasting sales is necessary for a number of important business purposes:
- To establish that the business is viable: to demonstrate that the business is likely to generate enough sales to make it a viable proposition, especially in the case of start ups, and to provide reassurance that it will eventually reach profitability even if this takes some time to achieve.
- To plan and manage cash flow: to use in a business plan to obtain funding, and to avoid unforeseen cash flow problems by establishing whether you will need to inject capital or borrow funds.
- To plan future resource requirements - for example, the number of staff needed to achieve your planned sales. An accurate sales forecast will also help in ordering the correct amount of stock.
- To plan production and marketing activities. It should indicate which products are the most successful, identify sales trends and help decide where to direct future investment.
- To set goals and targets for the business.
- To allow you to compare your actual sales with your forecast, understand the differences and use this information to produce new forecasts.
Sound market research will always form the foundation of your business plan, and this will be a crucial factor in obtaining funding.
A sales forecast in a business plan should show sales by month for at least the next twelve months, and then by year for the following two years. Three years, in total, is generally enough for most business plans.
The sales forecast should be prepared after consideration of the following issues:
- Market awareness
- Is there an established market for your product?
- What is the size of the market?
- Is the market growing or declining, and if so, by what percentage each year?
- Which factors are currently influencing that market?
- What may influence it in future?
- How do seasonal factors affect purchases of your product or service?
- Which trends or fashions are relevant to the sector?
- Develop a clear picture of your existing and potential customers.
- Be realistic about how many of these customers will wish to purchase your product.
- Detailed customer profiling can help determine strategy by enabling you to focus on niche markets, and hence affects pricing policy and sales forecasts.
- Make sure that the sales forecast is within the limits of your production capacity.
- How will any possible future changes in personnel or the size of marketing budget impact on future capacity to produce or to meet sales targets?
- How many competitors do you have? Even if your business appears to be unique, new competitors are likely to enter the market once you have done the groundwork to raise market awareness. If there are already many competitors this will probably indicate that there is an established market for your services.
- Be clear about how your products and services fit into the marketplace. How can you differentiate your business from your competitors' businesses?
- You may need to be flexible with regard to pricing and the range of products and services offered.
- Political, economic, socio-cultural, technological, environmental and legal (PESTEL) factors, such as energy prices, seasonal trends, interest rates, legislation, political and health issues, may all have an impact on your future plans.
- How do the economic climate and other external factors impact on your business and on your customers' attitudes and inclination to buy your type of product or service?
The approach to adopt when preparing a forecast depends on the maturity of the business, but all forecasts should be based on accurate and up-to-date market research.
All businesses need to base their forecasts on certain assumptions regarding potential changes that may take place in the future. These can be quantified and could include:
- An expectation of market growth or decline by a certain percentage, say 10%.
- Planned expansion in the number of employees to generate an expected 20% increase in production.
- A move to a new and better location that should produce a 50% increase in sales.
It will also be useful to break down projected sales by market, product or geographic region, and to consider the likely conversion rates from enquiries to orders.
A new business will have no previous historical data on which to base a forecast. Many formal methods of estimating future sales are really only useful if the business has been running for some time and has a history of sales trends from which to work. Accurate market research is crucial to the start up business as you will still need to make projections that can be justified.
Secondary or desk market research can be helpful; for instance, someone intending to open a bed and breakfast could obtain historical data on bed occupancy levels or visitor numbers from their local tourist board or Regional Development Agency. By multiplying average occupancy levels by price per-person per-night, while allowing for seasonality, sales projections can be calculated.
If you have no access to documentary research, or historical sales records, you can still carry out primary or field research among your target customer group. Interviewing potential customers, obtaining 'letters of intent' and testing the market with some advance / prototype products or services can provide useful information to estimate potential future sales. For instance, a person opening a restaurant or café could approach potential customers to ask:
- How often do you eat out?
- On average, how much do you spend on a meal?
Businesses which are already trading will have historical sales data on which to base their forecast, as well as a clearer picture of the market as a whole. You should keep accurate and up-to-date figures of previous sales on a monthly basis, and compare these with the targets you have set.
Future sales can be estimated on the basis of current trading levels, that is, on existing customers continuing to buy from your business for the foreseeable future.
However, your business may be in a position where sales have been growing, or even declining, steadily. In this case, you should identify the main trend in past sales, and then project this forward to give a general picture of future sales.
You should talk to key customers about any potential changes in purchasing patterns and review market trends regularly. It is also important to take into account the likely effect of any changes in sales strategy, such as additional marketing and price increases or decreases.
Existing businesses should not forget the importance of continuing to carry out market research, and include this information in their sales forecast. This is crucial to retaining a competitive edge and to ensuring that the forecasting process is based on current information and market intelligence.
Preparing your Sales Forecast
If you sell more than one product or service, you should prepare a separate forecast for each item in your range. Each forecast will need to consider:
- The volume you expect to sell; for example, how many units of the product will be sold per month. Product-based businesses sell in units, but so do many service businesses. For example, accountants sell hours of their time and restaurants sell meals.
- The price at which you expect to sell. The price charged will have an impact on the volume of sales, and the total revenue earned by the business is therefore equal to the volume of units sold, multiplied by the price of each item.
- The number of customers to whom you expect to sell. Are your sales one-offs or do you expect to achieve regular repeat business from each customer?
Sales in a restaurant can be forecast by looking at a reasonable expectation of the number of tables that will be occupied at different hours of the day and then multiplying the percentage of tables occupied by the average estimated revenue per table, based on assumptions about the number of meals sold and the average price paid.
By considering both volume and price, you can decide on a pricing strategy. Is your business going to sell a large volume at low prices, for example, if it is a fast food restaurant, or a low volume but at premium price, for example, if it is an exclusive French restaurant? You should consider what the market will bear, the costs to produce your goods and services and what you need to charge in order to make a profit.
It is also possible to calculate how many customers who fit the customer profile live within the area. Online resources are useful for this type of research. This will help with estimating:
- How often your product will be bought.
- How much you can charge for the product.
It may be that raising or lowering your price could impact significantly on sales. When preparing your forecast you will need to consider the impact of any decisions on total revenue and profitability.
From this, you can estimate the total number of sales per week/month/year for your business. These figures can be saved in a spreadsheet and plotted on a simple graph against high, medium and low monthly sales expectations.
It is important to compare forecasts (and sales records if appropriate) against potential capacity to ensure that what you are forecasting is achievable. You need to be sure that you have enough staff and resources to meet the expected production and sales targets or to provide the level of service required.
Other considerations, such as the target market, the location of your business and the quality of the product or service offered, will also contribute to decisions on pricing policy.
Pricing and Sales
Your pricing strategy is another marketing technique you can use to improve your overall competitiveness. Get a feel for the pricing strategy your competitors are using. That way you can determine if your prices are in line with competitors in your market area and if they are in line with industry averages.
Some of the pricing strategies are:
- retail cost and pricing
- competitive position
- pricing below competition
- pricing above competition
- price lining
- multiple pricing
- service costs and pricing (for service businesses only)
- service components
- material costs
- labor costs
- overhead costs
The key to success is to have a well-planned strategy, to establish your policies and to constantly monitor prices and operating costs to ensure profits. Even in a franchise where the franchisor provides operational procedures and materials, it is a good policy to keep abreast of the changes in the marketplace because these changes can affect your competitiveness and profit margins.
The forecasting method you choose will depend on the information your business wishes to gain from the process. If it has been trading for a time you can use data from past sales periods as a starting point and base your forecasts on these.
For a new business, you will be able to use these techniques after the first few weeks or months of trading and can then compare the actual sales figures with the projections you made after carrying out your market research.
A useful first step is to plot past sales data on a line graph in order to give a visual picture of seasonal patterns and general direction. In this way different sales figures can be plotted for different scenarios, enabling you to see clearly what would happen if sales grew or declined, and how different strategies might impact on the business.
You can also choose to plot sales levels by volume or value, or to calculate a percentage increase for annual sales.
A moving average is an indicator that shows the average level of sales over a given period of time. It can be a useful tool for forecasting, but does require the use of historical sales data to predict future increases or decreases. It is then possible to forecast sales for the year ahead so that a three-month and twelve-month moving average can be calculated and plotted on a line graph.
The three-month moving average smoothes out large monthly fluctuations but still gives seasonal variations. The twelve-month moving average, however, gives a general trend line.
The forecast three-month moving average for each month can be obtained by adding the expected sales figures for the current and previous two months and dividing by three.
The twelve-month moving average can be calculated by adding the forecast sales figures from the current month to the previous eleven months and dividing by twelve.
Once you have created the forecast, it should be put to good use. You should use it to set targets and prepare budgets, to raise finance, and to determine staff and resource requirements if necessary. The forecast will also give clues about how your business can shape its future strategy, by correlating sales with promotional spending or pricing.
In addition, you should compare actual results with the forecast, revise the forecast regularly as a result of this comparison, and carry out sensitivity analyses to consider the 'what if?' scenarios, such as what would happen to the forecast if customer numbers dropped by 10%.
Many of the elements involved in sales forecasting are inextricably linked with other parts of the business planning process, so be careful how you arrive at your assumptions. Follow the checklist below to avoid common pitfalls when forecasting sales:
- Is the forecast based on verifiable, realistic and unbiased market research information?
- Have you perhaps ignored the results of the research if it shows negative results?
- Don't make projections solely on the basis of historical performance. Keep looking at what else might affect your sales in the future and adjust the forecast accordingly.
- Is it physically possible to produce the amount of sales being forecast with the personnel, equipment and financial resources available to you, or is the forecast based on wishful thinking? That is, do you understand your capacity limits?
- Does the pricing policy used in calculating the sales forecast relate to what is really achievable, or conversely, have the prices been set too low so that either way the forecast is unrealistic?
- Do you understand the link between sales and costs, and hence the meaning of profitability? Remember the maxim that 'turnover is vanity, while profit is sanity'.
- When you prepared the sales forecast, did you also carry out sensitivity analyses?
- If you have just started up in business, have you considered that it may take longer for your enterprise to become established, and therefore for sales targets to be achieved, than you would like?
- Have you allowed for the possibility that high sales based on an initial promotional surge may drop off afterwards, leading to a need for more intensive marketing and higher ongoing costs?
- You should review your sales performance every month and compare this with the targets. This will help you to anticipate cash flow requirements and will also be useful when adjusting future forecasts.
- Computer spreadsheets and specialist software packages can make the forecasting process much easier.
- Can you identify and justify the assumptions you have made in reaching the forecast, and explain them to interested parties if necessary?
Here’s a final piece of advice. Even if you’ve worked hard and spent time gathering detailed knowledge which you used to make informed judgments, don’t stop when you develop a “final” set of numbers. Unless you’ve been unusually pragmatic in arriving at this first forecast, call it your best case. Now think of the things that are most likely to go wrong, assume that they will, change your spread sheets accordingly – and call that your worst case. Finally, it’s unlikely that everything will go against you but it’s equally unlikely that everything will go your way so take a third approach, which avoids either of the extremes, run the numbers again – and call that your most likely case.
When it comes to starting a business, entrepreneurs face a number of challenges, not least the issue of whether there is actually a demand for their particular product or service. The more unique the concept; the greater the challenge in predicting future sales levels. However, as this article will show, there are a number of methods that can assist you in making better educated guesses when forecasting sales for your goods or service.
Since time immemorial, people have sought to predict the future. Until the emergence of the relatively modern concept of ‘risk’ and the development of probability theory in the 17th century, predictions about the future had traditionally been the preserve of soothsayers such as Nostradamus. However, with probability theory, mathematicians demonstrated that one could use past indicators to make educated guesses as to the expected outcome of a particular set of events, e.g., the roll of a die. All these years later, and despite our progress, we still lack the ability to predict the future. Nevertheless, by considering various risks and probabilities, we can aim to understand some likely future (sales) scenarios to a greater degree.
Naturally, if you run an existing business, you will have a trading history and will be able to use this data to make more informed decisions with regards to future possible outcomes. If you generate strong cash flows and have a stable cost base, you can assess available investment options with more confidence. On the other hand, if you are just about to start up, you obviously lack ‘history’, and while you can make some assessment of the initial monthly outgoings (particularly fixed costs), the real challenge is to accurately predict the likely sales revenues. Breaking revenue down into its constituents (the product price times the quantity sold) gives entrepreneurs the two key figures they need to consider to begin forecasting. Price can be determined by the entrepreneur, while quantity is the variable that is most difficult to predict (notwithstanding the correlation between price and demand).
Why is forecasting important?
Firstly, cash is the lifeblood of any business and is needed to fund working capital to enable a business to run effectively. A large number of business expenses and investments in assets need to be paid for up front, and these obviously have to be paid for out of capital. These outgoings occur against a backdrop of uncertain sales levels and often a delay in receiving cash on those sales (exacerbated if your sales are predominantly on credit). Consequently, companies need to prepare cash flow forecasts to assess what the level of the cash shortfall will be, so they can obtain financial assistance in advance, such as bank overdrafts or loans. Companies can be profitable on paper yet run the risk of falling insolvent if they do not meet their obligations as they fall due. Hence, it is necessary to understand the nuances of cash flow for your particular business from Day 1, as good cash flow management plays a large role in ensuring continued solvency.
Of additional importance, investments in businesses are based on the ability of the firm to generate free cash flows, so as to reward the investor for taking a risk. The amount of cash generated and its timing is of particular interest to investors, who face an array of investment options with various risk / return tradeoffs. Typically, investors will look to review a business plan before they invest and they will pay particular attention to the predicted sales levels and cash generation capability of the company (as detailed in the cash flow forecast). Hence, these two factors underline why accurate forecasting is of vital importance to those setting up in business.
What forces affect demand?
At the start-up stage it is difficult to assess with certainty what you believe the revenue will be for Month 1. Once you have one month of trading, then of course you can use that month’s figures to forecast likely sales levels in subsequent months. As a result, when you draw up your business plan initially, you need to assess the landscape and try to estimate a range for the predicted sales levels.
The following represents a list of some questions about the key external and internal determinants of demand. Answers to these questions will support the entrepreneur in coming up with plausible figures for Month 1 / Year 1.
- Does the product or service fulfill an existing need?
- Has it been produced such that each key feature and resultant benefit is attractive to a commercially viable market segment?
- Is the product priced at a level that will attract a sufficient number of customers?
- Standard demand and supply rules would dictate that the lower the price, the higher the demand for a product. What price level maximizes profitability?
Macro Environmental Trends
- How is the product correlated to the external environment?
- Does demand drop significantly when the economy is struggling?
- Does the product attract extraordinary taxes or tariffs, e.g., alcohol and tobacco?
- Will a growing environmental consciousness affect demand levels?
- What is the competitive landscape like, i.e., are there barriers to entry/ attractive alternatives?
- What is the turnover of a close competitor and how profitable are they?
- Is there any seasonality or cyclicality element to the product or service?
- Are there many attractive substitutes? What are the main bases for differentiation in the market, i.e., price, features, service, etc.?
- What is the market demand for the product category (i.e., the size of the prize you are chasing)?
- Is it growing or is it stagnant?
- Is there a marketing plan in place?
- What are the key marketing activities?
- Is there sufficient budget to effectively target various segments?
Route to Market
- Has the company secured a ‘route to market’?
- How will customers access the product?
Having assessed the various determinants of demand, it is now a little easier to hone in on a plausible range of sales forecasts for the months and years ahead.
Making A Sales forecast?
Once you have considered the context, you are now in a more informed position to consider potential revenue figures. There are two main elements to forecasting – the use of facts and the use of subjective assessment / judgment. Given the uncertainty, you can aim to identify a range for the sales predictions depending on your assessment of the potential impact on sales of specific conditions, be they environmental or company-specific (or a combination of both).
There are numerous determinants of demand, ranging from the performance of the overall economy to whether there is any appetite (demand) for your particular product or service. You need to consider which of these is likely to have the biggest impact on your offering.
Ideally, you should be able to obtain a Profit and Loss / Income Statement (facts) for a competitor and you could use that as a reference point to assess likely demand levels for your company (judgment).
Looking for comparable indicators for a service
Not every new company has a directly comparable competitor whose accounts can be scrutinized for sales data. However, no matter how unique your concept is, if you define your market widely enough, it is likely that you can use figures from alternative offerings (facts) to help you assess likely demand levels (judgment).
For example, when the Millennium Dome was being launched in London in 2000, they initially targeted 12 million visitors in Year 1. While the actual visitor figures reached an impressive 6.5 million, the huge shortfall in numbers meant that it was not even close to breaking even / financial viability and it ultimately failed as a venture.
Had senior management looked closely at visitor figures for the UK’s other top paying attractions, they would have found that Alton Towers was top at 2.65 million visitors closely followed by Madam Tussaud’s and the Tower of London. These proxies would have given them a clearer sense of the range in numbers and a more conservative target within this range would have resulted in a very different proposition / investment structure from Day 1.
If you are looking to set up a local service such as a coffee shop, there are also numerous resources you can use in assessing likely demand. The facts from these sources need to be backed up by judgment.
If, for example, you were looking to open a coffee shop you would start with a list of likely costs, ranging from rent through to set-up, etc. Once you had an estimate of the costs, you would then look to work out the revenues. To do this, you could park a car outside of a particular target location for the shop and count “footfall” for the day. You could also obtain average spend per customer, estimate a percentage conversion rate from the footfall and use these figures to assess whether you believed you could break even by relying on passing trade.
You could also drive around the neighborhood looking at competitive coffee shops and their locations. Hence, by using a number of different data points, you can now make a more informed decision on the financial viability of a coffee shop. If you want to get more scientific, you could assess how consumption of coffee is correlated with the economy (i.e., will less be consumed in a down turn) and also whether you needed to stock alternatives to boost average spend e.g. fair trade coffee / non coffee-based alternatives or food. As mentioned previously, there is no exact number – you are merely striving to produce a good educated guess, i.e., a plausible figure that is within a range for a typical company in that field.
There are a number of different methods to try to assess sales levels for a new product. Firstly, by assessing the key benefits of the product, it is possible to understand the core need being fulfilled. This will then help inform you of a category of complements or substitute products it belongs to.
The top down approach seeks to drill down from the total population to a final market segment, whereas the bottom up approach looks to generalize from the consumption of individual customers.
How do you make a more accurate sales forecast?
Having assessed the wider environmental conditions and considered the internal decisions regarding the proposition, it is possible to make more accurate predictions for Month 1. After that, it is a case of extrapolating into the future using a growth factor and flexing for seasonality or cyclical trends. Notwithstanding the difficulties in forecasting for a start-up, the real benefits accrue after a year of successful trading. Once there is an historical record for a year of trading, it is then possible to plan with more certainty through the use of more scientific methods, such as trend analysis and comparison with variables. For example, an ice cream vendor could compare sales of ice cream with an obvious variable – weather temperature – in order to assess the correlation between the two variables. Once a sales forecast has been made, it can then be used for budgeting, allocating resources, managing cash flow, and as a basis to secure investment.
The aim of sales forecasting is to come up with some revenue figures that can be considered to be credible in the wider context. As illustrated above, forecasting is not an exact science but a mix of fact-based analysis and judgment. Placing some rigor around the process of deriving credible revenue figures also serves the entrepreneur by enhancing their awareness of some of the key drivers for revenue growth in their business. It will also help them to produce a more plausible business plan, and ensure that the author is confidently able to answer questions regarding the market opportunity – questions that will top the list of any prospective investor or bank manager.
A strong Business Plan may not guarantee success; but it could certainly prevent failure!
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