Conduct a Sales Forecast

Overview

A sales forecast is a prediction based on past sales performance and an analysis of expected market conditions. The true value in making a forecast is that it forces us to look at the future objectively. The company that takes note of the past stays aware of the present and precisely analyzes that information to see into the future.

Conducting a sales forecast will provide your business with an evaluation of past and current sales levels and annual growth, and allow you to compare your company to industry norms. It will also help you establish your policies so that you easily can monitor your prices and operating costs to guarantee profits, and make you aware of minor problems before they become major problems.

After reading this article, you should understand:

Outline:

  1. The Importance of Sales Forecasting
  2. What Information Is Needed to Prepare a Sales Forecast?
  3. How Long and How Often Should One Forecast?
  4. Forecasting Techniques
  5. How Sales Forecasting Applies to a New Business
  6. How to Produce a Sales Forecast You and Your Staff Can Believe In
  7. Benchmarking - Actual Sales vs. Forecast
  8. Who Should Prepare Sales Forecasts?
  9. Software as a Tool for Sales Forecasting
  10. Resources


I. The Importance of Sales Forecasting

Sales forecasting is a self-assessment tool for a company. You have to keep taking the pulse of your company to know how healthy it is. A sales forecast reports, graphs and analyzes the pulse of your business. It can make the difference between just surviving and being highly successful in business. It is a vital cornerstone of a company's budget. The future direction of the company may rest on the accuracy of your sales forecasting.

Companies that implement accurate sales forecasting processes realize important benefits such as:

  1. Enhanced cash flow
  2. Knowing when and how much to buy
  3. In-depth knowledge of customers and the products they order
  4. The ability to plan for production and capacity
  5. The ability to identify the pattern or trend of sales
  6. Determine the value of a business above the value of its current assets
  7. Ability to determine the expected return on investment (This can be very helpful if the company is trying to obtain financing from investors or other lending institutions)

The combination of these benefits may result in:

For sales forecasting to be valuable to your business, it must not be treated as an isolated exercise. Rather, it must be integrated into all facets of your organization.
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II. What Information Is Needed to Prepare a Sales Forecast?

Since the forecast is based on your company's previous sales, it is necessary to know your dollar sales volume for the past several years. To complete a thorough sales forecast, you also need to take into consideration all of the elements, both internal and external, that can affect sales.

Mathematically, it is possible to forecast sales with some precision. Realistically, however, this precision can be dulled because of external market and economic factors that are beyond your control. The following are some of the external factors that can affect sales:

Sales forecasting requires sufficiently detailed analysis of both the external and internal factors related to the sales function. Internal factors that can affect sales are somewhat more controllable, such as:

The sales forecast must be qualified by asking the following questions:

  1. What are the items to be forecasted (individual product lines or business units)?
  2. How far in the future should the forecast extend?
  3. How frequently should the forecast be made?
  4. How frequently should the forecast be reviewed?
  5. What would constitute an acceptable tolerance of forecast error?

The following internal data will be scrutinized and analyzed when conducting a sales forecast. Therefore, this data must be prepared on a consistent basis:

  1. Accounting records
  2. Financial statements
  3. Sales-call reports
  4. After-sales service demands from clients

It is significant to note that if you sell more than one type of product or service, you should prepare a separate sales forecast for each service or product group. The more focused your sales forecast is, the more precise its outcome will be.
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III. How Long and How Often Should One Forecast?

A sales forecast needs to be performed, reviewed and compared with actual performance results on a regular basis. Think of it as a routine tune-up that keeps the gears of your business running smoothly so your company can achieve a higher performance record.

Although every business owner's comfort level may be different, sales forecasts should be conducted monthly during the first year, and quarterly after that. The more often you forecast, the better your chances of weeding out extreme variations in year-to-year sales. It will also possibly identify a trend or level of variations that is more realistically oriented to probable future sales patterns.

Although any forecast has a percentage of uncertainty, the farther into the future you project, the greater your uncertainty. As a rule, there are three lengths of time for sales forecasting:

  1. Short-range forecasts are for fewer than three months. They are used to make continual decisions about planning, scheduling, inventory and staffing in production, procurement and logistics activities.
  2. Intermediate forecasts have a span of three months to two years. They are used for budgetary planning, cost control, marketing new products, sales force compensation plans, facility planning, capacity planning and process selection and distribution planning.
  3. Long-range forecasts cover more than two years. They are used to decide whether to enter new markets, develop new products or services, expand or create new facilities, or arrange long-term procurement contracts.

Perhaps the simplest method is to assume that the percentage increase (or decrease) in sales will continue and that no market factors will influence sales performance more in the future than in the past.
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IV. Forecasting Techniques

Sales forecasting isn't that difficult. In fact, even if you've never conducted a formal, written forecast, you've probably used at least some sort of informal method, whether you know it or not. To prove this point, answer the following questions.

  1. Have you ever questioned your inventory requirements?

  2.  YesNo
  3. Have you ever checked that there were sufficient salespeople to cover all territories?

  4.  YesNo
  5. Have you ever questioned your total sales?

  6.  YesNo
  7. Have you ever checked what volume has been achieved with a specific customer?

  8.  YesNo
  9. Have you ever analyzed what causes a slump or jump in sales in a particular region?

  10.  YesNo

If you answered "Yes" to any of these questions, you've conducted an informal sales forecast.

There are two main approaches to sales forecasting: quantitative and qualitative, or judgmental. Often companies utilize both methods at the same time.

Simply stated the word quantitative means estimating a particular, indefinite or considerable amount of anything. Quantitative techniques rely primarily on numbers to conclude forecasts. These numbers are multiplied, added or correlated and then placed in a formula to predict the company's sales. You can start by building up to aggregate totals of market demand, or start with these totals and work the numbers down into more focused forecasts for individual products. Quantitative techniques are calculated from important numbers such as sales volume, gross national product, disposable income, and total number of buyers in the market. These numbers have been shown to have significant value in forecasting.

If demand for your product is highly stable and predictable, the forecast consists of past sales and inflation to predict future sales. In formula form, it is simply: Past Sales + Percentage of Inflation Factor = Sales Forecast

Monthly Forecasts

In the event that monthly variations over a period of years have been small, another method of forecasting can be based on the distribution of sales by months.

Suppose, for instance, that a short-term forecast is being made for the month of October. For the past several years, sales in October have totaled 12.5 percent of annual sales. During the same period, August sales have averaged 10 percent of annual sales. Sales during the previous August were $16,000. $16,000 / .10 = $160,000 (estimated annual sales)





Projected sales for October will be 12.5 percent of $160,000 (or $20,000). Sales for other months can be forecast in the same way.

Next Step: Compute Your Monthly Sales Forecast (Qualitative Method)

(Remember that if you sell more than one product or service, you'll need to prepare a separate forecast for each line and combine them to get a company-wide forecast.)

Enter your last month's sales $
Enter the percentage of annual sales this figure historically represents %
Estimated annual sales = $
Enter the percentage of annual sales the forecasted month's sales typically represent %
Sales forecast = $

Annual Sales Forecasts

A good starting point for any company conducting an annual forecast is the prior year's sales. Let's say in the last year, for example, Company X, a clothing manufacturer, has sales of $1 million. We will make several assumptions in determining Company X's sales for the current year. First, the company expects all of its current customer contracts to be renewed, and they expect to land a new contract worth $100,000. Finally, we are assuming apparel industry experts' predictions of 10 percent market growth in the current year are accurate. The sales forecast calculation would be as follows:

Last year sales = $1,000,000

Value of new contract in the current year = 100,000

Total projected sales = $1,100,000

Projected market growth = .10

Current year sales projection = 1,100,000 (.1) = 110,000 110,000 + $1,000,000 = $1,210,000

Next Step: Compute Your Annual Sales Forecast

Project your current year annual sales by entering the figures for your own company into the following formula.

Last year sales = $
Total value of additional contracts you expect to land during the next year = $
Total value of contracts that will not be renewed during the next year = $
Projected sales subtotal = $
The percentage increase projected by experts for your industry's growth = %
-OR-
The percentage decrease projected by experts for your industry's decline = %
Current year sales forecast = $

Keep in mind that fluctuations can result between your projected sales and actual sales due to uncontrollable external factors, such as economic and political changes, employee turnover, technical and mechanical difficulties, and trend shifts.

If the market behavior becomes less predictable, more diverse and complex forecasting methods are necessary. Many more factors need to be researched and placed into the formula. Generally forecasters will use more than one method.

The following is a list of the different quantitative techniques; more detailed information can be found in most introductory books on statistical methods.

  1. Correlation analysis, which uses one set of data to forecast another set of highly correlated data.
  2. The market factor index method, which uses a formula incorporating factors predictive of sales volume to derive a market index figure.
  3. The chain ratio method, which multiplies a base number by various qualifying percentages to derive forecasts.
  4. The total market demand technique multiplies number of buyers by expected number of purchases, and cost per buyer, to derive forecast figures.
  5. The market buildup approach, which totals estimated sales figures for individual products or market segments to derive forecast figures.
  6. Time series projections, which projects past sales trends into future periods. It considers, trend, cycle, seasonal and random factors.

Qualitative, or judgmental, forecasting does not rely on numbers to conclude forecast, but rather on intangible factors. This method is especially common when sufficient historical data isn't available, i.e., for a new business or a less-established market environment. Groups whose judgment is normally surveyed in preparing a qualitative forecast include the experts in the field, the sales force and the customers. Combining historical data with the judgment of people or groups presumed to have superior knowledge of sales only adds to the reliability and integrity to a company's sales forecast. Experience has proven that grass roots forecasts can be surprisingly accurate.
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V. How Sales Forecasting Applies to a New Business

Statistics show that 80 percent of new business startups never survive the first three years. Nine out of 10 of those business failures are caused by poor management decisions. Implementing sales forecasting forces a new business to base decisions on facts rather than hunches. Since you have no historical information on your new business, i.e., past sales, you need to look elsewhere.

You need to consider the following:

  1. How well does your competition satisfy the needs of its potential customers?
  2. Note the population and economic growth in your location.
  3. Develop a customer profile.

Experienced business people will tell you that a good rule of thumb is that 20 percent of your customers account for 80 percent of your sales. If you can identify this 20 percent, you can begin to develop a profile of your main markets.

After you've identified your primary markets, then you need to determine trends in your industry. Now you need to know the approximate size and location of your planned trading area. Your trading area is how far your average customer will travel to shop, as well as how far you are prepared to distribute and promote your product or service. It is helpful to recognize the personality of your trading area, which can be found by talking to other neighborhood business owners, contacting the Chamber of Commerce, and reading the local papers.

At this point, you should be able to estimate your sales on a monthly basis for a year. The basis for your sales forecast could be the average monthly sales of a few similar-sized competitors that are operating in a similar market.

To estimate their sales, you have to list, profile and study your competitors. This is accomplished by visiting either their stores or the stores where their products are offered. You need to analyze their customer volumes, the location, hours of operation, traffic patterns, busy periods, quality of their goods and services, prices, product lines carried, promotional techniques, positioning, product catalogues and other handouts. If possible, talk to customers and sales staff.
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VI. How to Produce a Sales Forecast You and Your Staff Can Believe In

Though sales forecasting may seem number-driven, to succeed it needs to be people-driven as well. That means that the people in your business need to feel part of achieving the sales forecast. There are some simple rules you can follow to increase the probability of getting a forecast you can count on and one that people will do whatever is necessary to achieve.

Action Plan for Achieving Forecasting Buy-In From Your Staff:

  1. Share your expectations. Salespeople need to know the annual sales growth rate that you are looking for. Information and communication are key ingredients in securing an accurate sales forecast. It also creates a feeling of personal responsibility for the results.
  2. Ask the right questions and insist on real answers. The real answers will contain evidence to support the numbers. Evidence means hard facts, not merely hunches, about what will directly affect your customers and their future purchasing decisions. Insist that everyone in your organization do their homework and talk to customers on a regular basis.
  3. Make sure your salespeople understand that a sales forecast is for everyone's benefit. Personalize the numbers by showing how the success of your company is tied to the success of its employees. Also, point out exactly how each department's role fits into the bottom line.
  4. Ensure accuracy in the sales forecast to prevent unforeseen layoffs or scrambling to find new personnel. Employees should feel confident that solid projections will ensure the safety of their jobs.
  5. Get a second opinion. Have the forecast checked by a financial or accounting professional. Show them the factors you have considered and explain why you think the figures are realistic.
  6. Once you believe the numbers are substantiated, accept what they say about your company. From that point on, all efforts should be directed toward meeting the projection. Regularly review and revisit the figures with key employees on a monthly basis to ensure that you're on track. Your skills at forecasting will improve with experience, particularly if you treat it as an ongoing "live" forecast.

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VII. Benchmarking - Actual Sales vs. Forecast

It's a given that no one can forecast with 100 percent accuracy. Yet we can say with 100 percent accuracy that a poor forecast will negatively impact your company. Of course, you'll never completely eliminate the uncertainty in forecasts, but you can reduce it to a manageable level. By collecting proven facts and testing any major assumptions in a forecast before you conduct the forecast, you can greatly reduce the guesswork and increase the accuracy of your forecast.

Problems arise not only when forecasts are too high, but also when they are too low. If a forecast is too optimistic, cash is often tied up in slow-moving inventory, and profit margins are reduced due to wasted overhead. On the other hand, if a forecast is too pessimistic, the result is poor delivery performance, dissatisfied customers and shortfalls in revenue because of limited product availability. Trends between past forecasts and actual performance need to be established and fed back to the forecaster to correct their optimism or pessimism in future forecasting.

There are a number of reasons for slight deviations between projections and actual performance. Perhaps the forecasting process was viewed separately from the rest of the organization; or external factors, such as trends or new legislation, weren't taken into consideration.

Significant discrepancies, however, such as a deviation of 15 percent or more in a month, or a cumulative deviation of 10 percent in a year, signals a need for much more detailed analysis to determine what has occurred.

Self-Assessment

Answer this questionnaire to determine the soundness of your company's sales forecasting system.

  1. Are customer requirements analyzed in the development of your forecast?

  2.  YesNo
  3. Does your sales forecast include a buffer to allow for error?

  4.  YesNo
  5. Is the best judgment of the group exercised in improving forecast data, methods and techniques used?

  6.  YesNo
  7. Are changes in the forecast promptly reflected in production and inventory planning?

  8.  YesNo
  9. Are your sales forecasts tracked by comparing actual demand with the forecast?

  10.  YesNo
  11. Are your sales forecasts reviewed regularly by sales, distribution and manufacturing?

  12.  YesNo

If you answered "No" to any of the questions, you will want to question the integrity and accuracy of your projection methods.
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VIII. Who Should Prepare Sales Forecasts?

Most business experts agree that sales forecasting should be a joint effort. Generally the best people to perform such activities are those most closely involved with the company's sales activities. Involvement includes not only direct relationships with customers, but also an awareness of market conditions. Including key staff members from production, inventory management and marketing promotes a spirit of teamwork and improves your ability to make projections.

The decreasing cost of personal computers has made it possible for small- and mid-sized companies to handle forecasting internally. However, there are also many firms that you can contract with to assist you. Locate them by obtaining referrals from your peers or checking trade publications.
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IX. Software as a Tool for Sales Forecasting

Projections become even more precise when software programs written specifically for sales forecasting are utilized. Investing in a simple but effective forecasting package can also free up the time of valuable personnel. All basic sales forecasting software packages evaluate the history of your business, extrapolate pertinent information, and offer a forecast of your company's future.

When shopping for a good software package, look for the following features:

  1. Capability to adjust for special factors, i.e., promotion and price changes
  2. Documents underlying forecasting assumptions
  3. An effective management review and communication step
  4. Historical data-tracking and plotting of current performance against past trends and future projections
  5. Allows multiple parties (e.g., sales, marketing, manufacturing and logistics) to enhance, manipulate and use the forecast

Unfortunately, such programs are not usually stocked in computer software stores. To locate the companies that produce this type of software, you can contact professional associations, check ads in your professional magazines, and talk with other businesspeople for recommendations. The Internet is a great additional source for seeking out these companies, and a simple search will bring up several choices.

As you research forecasting software you will find those that run the gamut of very affordable to very expensive. Some examples include: Strategic Planning Software ($29), Ward System Group's Neuroshell PREDICTOR ($395) and ParkerSoft Products' Exforecaster 1.0 ($99) and Fastcast ($600.00).

Before purchasing a program, it is advisable to either download or request a demo program for evaluation. Be aware that some software programs are not stand-alone and often require another program such as Excel and Oracle Personal Express to be installed on your computer.

Sales forecasting is an unwieldy and difficult process, yet doing it correctly is key to understanding what's in store for your business' future. The numbers you come up with will permeate almost every aspect of your company, making it all the more important to ensure accurate forecasts. By using the information presented here, you can develop a realistic projection for the future performance of your organization.
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X. Resources

Evetts, Jonathan, "Seven Pillars of Sales Success." Sterling Publishing Co., 1990.

Bangs, Jr., David H. Bangs, "The Start Up Guide." Upstart Publishing Co., 1989.

Leza, Richard L and Placencia, Jose, "Develop Your Business Plan." The Oasis Press, 1988.

Bangs, Jr., David H. Bangs, "The Market Planning Guide." Upstart Publishing Co., 1998.

Burstiner, Irving, "The Small Business Handbook." Simon & Schuster Inc., 1997.

Resnik, Paul, "The Small Business Bible." John Wiley & Sons, Inc., 1988.

American Marketing Association

National Federation of Independent Businesses

International Council for Small Business

U.S. Department of Commerce

U.S. Small Business Administration

Quicken

Business Online Business Links

Small Business Information/Mining Company

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