Inaccurate forecasting of sales can lead to wrong results. Growth figures are either anchored around “inflation plus x,” or a round number is thrown out at random. This tutorial explains the sales forecasting process and how it can benefit businesses beyond setting top-line goals.
It’s not a waste of time to forecast sales.
For a business to be successful, it must have a sales forecast. This is influenced by:
Decisions and tools for strategic action: Forecasts of sales can be used to identify trends and issues and give the necessary direction in order to capitalize on them or correct them. A negative deviation of 20 percent from the target sales could indicate poor management or that competitors are stepping up their game. A significant upswing in sales will be welcome, but it will also suggest that additional resources (e.g., more staff) will be needed going forward. Identifying problems and needs early on can help you take timely action to seize opportunities.
A way forward: While a downward deviation from the sales forecast can be disappointing, it is also an opportunity to draw a boundary. Setting clear goals and motivating the team with meaningful action plans and landmarks can be helpful.
Financial models that forecast sales: The importance of careful sales forecasting in financial modeling exercises
Cash Flows: Sales revenue directly impacts cash flow. Accurate estimations of sales can provide insights into cash flows and allow for planning future shortfalls or windfalls.
Inventory: A good forecast takes into account macro-increases or decreases in demand, as well as changes in customer behavior. This allows for more efficient inventory planning, which in turn increases working capital efficiency. This can also have a tangential impact on the planning of labor and raw materials.
Factors To Consider When Predicting Sales
Sales will almost always differ from forecasts, as we have already mentioned. The greater the deviation from the prediction, the more significant the knock-on effect on the business.
Forecasting analysts should consider possible scenarios or have contingency planning in place. Unexpected events can have a huge impact on the operation of a business. Examples include unforeseeable economic factors (e.g., stock market crashes) and legislative or policy changes.
Sales forecasting is important, but it shouldn’t be the sole scapegoat. A firm may suffer from significant losses or lose market share if predictions are wildly off. A holistic post-mortem should be conducted to determine how the entire business was responsible for the failure.
Quantitative and qualitative forecasting each have their distinctive features that must be taken into consideration. Due to the subjective nature of qualitative methods, it is important to develop a holistic perspective and then qualify this with credible and well-rounded research. On the other hand, quantitative forecasting models can reveal trends but could still suffer from biases such as the correlation/causality paradigm.
Finally, the sales forecasts are closely linked to a company’s general strategy and high-level milestones. Forecasting models need to be updated regularly as conditions change.
What are the main approaches to sales forecasting?
Sales forecasting can be done in two ways: top-down and bottom-up.
Top-down: With a top-down approach, we begin with the big picture before working our way downwards. We define the milestones needed to achieve the target. If there are 1.8 million smartphones in the world, and we aim to capture 1% of that market, then our target will be 18 million customers. This can lead to a situation where unrealistic expectations are created if done in a hasty and unclear manner.
Bottom-up: We look at micro-assumptions based on the company’s resources. An example would be the number of sales that can be made by a salesperson or the number of times an ad will convert into a deal. This allows companies to analyze the efficiency of their operation and identify ways to boost sales. The more information that a business has about its past performance, the better it can forecast in this area.
What is the best approach?
The top-down method can lead to subjective and overly optimistic predictions. However, it is useful in establishing milestones quickly that become benchmarks for the entire organization. The bottom-up approach is more accurate and conservative, but it’s also more conservative. As with financial models in general, a bottom-up perspective can provide a structured and realistic view of sales forecasting. This can be enhanced by a strategy perspective as well as some top-down analysis.
What are the main methods for sales forecasting?
There are two main methods for sales forecasting: quantitative and qualitative.
Quantitative Sales Forecasting
Quantitative forecasting is the analysis and gathering of numerical data, such as consumer trends and economic trends. Quantitative models come in many different forms. They are linear models in their simplest form.
When testing, trends, and seasonal effects are added to the equation, these formulas become much more complex. Quantitative methods may not be the best choice for a brand-new business with no history, but they are very helpful for a well-established one. A quantitative model can be used to determine seasonal trends, cyclical effects, and more for a midsized clothing company. It would allow them to make more accurate forecasts of sales and, therefore, plan their inventory better.
Qualitative Sales Forecasting
Expert and individual opinion is used to create qualitative sales forecasts. This method is especially useful when there are no historical data. There are four categories of qualitative forecasting.
Jury opinion of executives: In this method, ideas are gathered from a group and then compiled to form a consensus. This method is fast, simple, and based on informed opinion. However, not every executive is equally knowledgeable in sales, and their views may not have the same weight when it comes to commercial realities.
Delphi Technique This technique is similar to the previous one in that it averages opinions from company executives but also adds external expert counsel. It can produce more balanced results but is time-consuming and expensive.
Sales force composite: Using this technique, you can get the opinions of your sales force and use them to create sales forecasts that are accurate and affordable. The sales force, however, may not have the same strategic insight as managers. There may be perverse incentives at play when, for example, the sales force predicts lower-than-expected sales to make benchmarks more achievable.
Survey on buyer intentions This method is based on the demand side and the definition of a consumer to purchase a product or system. The forecasts are more accurate when they focus on the end client. This is because reliable public data can provide some additional layers of information (e.g., economic indicators of the US Census Bureau).
In order to create holistic forecasts, a firm can use a combination of these methods. This will allow them to make robust assumptions and give each technique more or less importance depending on how well it fits their business. A company with an inexperienced sales team may not value a composite sales projection as highly. A rational approach is the best way to ensure accurate forecasts, given the nuance of deciding on the right techniques and weighting. When deciding on the right mix of methods for forecasting, an expert’s input can be invaluable.
Build Your Own Sales Forecasts
Calculating net sales is easy. The forecasted sales are calculated by multiplying the units indicated by the price. Then, we perform the same process for direct costs. We then subtract these (COGS from sales) to arrive at the net sales.
Divide the gross sales by the net sales to get the expected gross margin. This should be done for each month in the first year and then every quarter for the next two years.
Let’s start with the costs.
An organization has greater control over expenses than revenues. Forecasting expenses is easier from this perspective. We can create cost categories and analyze each one granularly in order to find more accurate points. If marketing is an important driver of sales, then instead of placing it as a number in a generic overhead category, we can segment the cost further (e.g., Google Ads or social media ads) for greater accuracy.
