How Sales Forecasting Works


Just like a ship's captain, it's up to sales forecasting professionals to keep businesses on course.
Just like a ship's captain, it's up to sales forecasting professionals to keep businesses on course.
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Managing a business is a little like running a ship. As the ship's captain, you  need to keep your eyes on the horizon to plan your next move. If there are storm clouds gathering, you must secure the ship's cargo and warn the deck mates to take cover below. If there are rocky waters ahead, you have to ask your crew to stand watch to help you n­avigate safely to the other side. If the next leg of the journey is going to be long, you need to stock up on food and supplies before leaving port.

In business, there's less chance of losing an employee to scurvy, but it's equally important to plan ahead and keep your eyes on the horizon. And the best way to plan for the future is to carefully analyze trends from the past. This is especially true when predicting future sales of a product or service.

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Sales forecasting uses past figures to predict short-term or long-term  performance. It's a tricky job, because so many different factors can affect future sales: economic downturns, employee turnover, changing trends and fashions, increased competition, manufacturer recalls and other factors. But there are several standard methods that can produce consistently accurate sales forecasts from year to year.

Without sales forecasts, it's very difficult for you to steer the company in the right direction. You wouldn't know that the spring is always the slowest season, so you'd invest too much in inventory that would just sit on the shelves. You wouldn't pay attention to industry analysts who predict a robust growth in holiday sales, and you'd lose potential customers to the competition, which doubled its holiday sales force and marketing campaigns.

Exactly how important is sales forecasting to the sound financial planning and management of a business? And what are some of the methods and technologies that ensure the most accurate and dependable forecasts? Read on to find out more.

Importance of Sales Forecasting

Sales forecasting helps retailers decide how many styles of a product to stock.
Sales forecasting helps retailers decide how many styles of a product to stock.
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Sales are the lifeblood of a business. It's what helps you pay employees, cover operating expenses, buy more inventory, market new products and attract more investors. Sales forecasting is a crucial part of the financial planning of a business. It's a self-assessment tool that uses past and current sales statistics to intelligently predict future performance.

With an accurate sales forecast in hand, you can plan for the future. If your sales forecast says that during December you make 30 percent of your yearly sales, then you need to ramp up manufacturing in September to prepare for the rush. It might also be smart to invest in more seasonal salespeople and start a targeted marketing campaign right after Thanksgiving. One simple sales forecast can inform every other aspect of your business.

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Sales forecasts are also an important part of starting a new business. Almost all new businesses need loans or start-up capital to purchase everything necessary to get off the ground: office space, equipment, inventory, employee salaries and marketing. You can't just walk into a bank with a bright idea and lots of enthusiasm. You need to show them numbers that prove your business is viable. In other words, you need a business plan.

A central part of that business plan will be the sales forecast. Since you won't have any past sales numbers to work with, you'll have to do research about related businesses that operate in the same geographical market with a similar customer base. You'll have to make concessions for the difficulty of starting from scratch, meaning that the first few months will be lean. Then you'll need to convince the bank that your business has fresh ideas that will eventually outsell the competition. All of these ideas need to be expressed as numbers -- losses, profits and sales forecasts that the bank can easily understand. 

As your business grows, sales forecasts continue to be an important measurement of your company's health. Wall Street measures the success of a company by how well it meets its quarterly sales forecasts. If a company predicts robust sales in the fourth quarter but only earns half that amount, it's a sign to stockholders that not only is the company performing poorly, but management is clueless. When attracting new investors to a private company, sales forecasts can be used to predict the potential return on investment [source: Virtual Adviser Interactive].

The overall effect of accurate sales forecasting is a business that runs more efficiently, saving money on excess inventory, increasing profit and serving its customers better [source: Virtual Adviser Interactive].

So what are some of the standard methods for creating a sales forecast? Does it require a lot of complicated math? Find out on the next page.

Sales Forecasting Methods

With sales forecasting, companies can plan for future inventory on a monthly basis.
With sales forecasting, companies can plan for future inventory on a monthly basis.
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The math involved in sales forecasting is actually quite simple. The hard part is maintaining the detailed and accurate financial records needed to make those calculations. Here's some of the most useful information for calculating sales forecasts:

  • Sales numbers for each product broken down by month of the year
  • Number of sales that are returned or canceled
  • External factors impacting sales, such as economic forecasts, price changes in raw materials, employee contract renegotiations, increased competition, among others

The simplest sales forecasting method is an annual sales forecast. Assuming that your sales are relatively stable -- no major changes in your competition, your employees or your customer base from year to year -- you only have to account for inflation. Here's the formula:

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last ­year's annual sales + (last year's annual sales X rate of inflation) = next year's sales forecast [source: Virtual Adviser Interactive]

An example would be:

­$100 in sales last year + ($100 X .03 rate of inflation) = $103 in sales for next year

For many businesses, sales fluctuate with the seasons. If that's the case, then you can break down your sales forecast month by month. The first thing you have to do is analyze the past few years of sales figures to calculate what percentage of the year's total sales are made each month.

In January, for example, you might make 5 percent of your total annual sales, but in June you make 20 percent. With that information, you can use current monthly sales numbers to predict the total sales for the year, no matter if it's the high season or the low season.

Let's say it's February and you already have the sales numbers for January. Since you know that January usually accounts for 5 percent of the year's total sales, you can make a forecast for the rest of the year. Here's the formula:

monthly sales / percentage of total sales expressed as a decimal = annual sales forecast

Let's says you made $100 in sales in January. Here's the formula:

$100 in January / .05 = $2,000 for the year

Of course, it's rare that a company's sales remain so stable from year to year, even with seasonal variations. When making sales forecasts, there are several other factors that may need to be added to the calculation:

  • Sales contracts that won't be renewed
  • New sales contracts that are on the horizon
  • Industry analysts' predictions for growth or shrinking in your market segment
  • Economic analysts' predictions for the increased or decreased buying power of consumers in your market
  • Political changes that could effect government contracts

One of the hardest things is forecasting for a new business that has no proven sales. At this stage, sales forecasts are important for attracting investors and qualifying for loans. The standard method for calculating a sales forecast with no existing sales is to base your predictions on the performance of similar businesses that sell similar products.

It's important to base your predictions on businesses that sell to the same customer demographic and have the same geographic location. For retail sales, you'll want to figure out the average monthly or annual sales volume per square foot of retail space. That way you can adjust for the relative size of your store.

Visit your competition, talk to sales staff and customers and draw up a profile of your target customer. Using census data, find out how many people in your area fit that customer profile and use that information when making your sales forecasts.

What tools can help you calculate sales forecasts? On the next page, we'll find out.

Sales Forecasting Tools

Many business accountants use sales forecasting software to make projections.
Many business accountants use sales forecasting software to make projections.
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Computer software has made business accounting considerably easier. Everything can be kept in one place -- no more file cabinets stuffed with paper -- and data-intensive spreadsheets can be quickly transformed into easy-to-understand charts, graphs and reports. An increasing number of desktop software and Web-based services focus on generating sales forecasts.

The simplest solution is to use a desktop accounting program like QuickBooks Premier or Quicken Small Business. The advantage of these programs is that they use all of the data you enter into the system to make sophisticated predictions about next month's or next year's performance. The software can make forecasts in two ways: either by automatically mining data already in the system, or by walking you through a step-by-step worksheet that collects all the necessary information to make the calculations.

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Companies are beginning to migrate to Web-based accounting and business management software. These are record keeping and collaboration tools that are accessible through a normal Web browser.

Sales managers already use these programs to keep track of their team's performance and to identify the best sales leads. These programs also make it easy to generate sales forecasts based on the past performance of each  sales team member. The software identifies trends (a 5-percent monthly gross in Margaret's sales over the past three months, a 2-percent drop in Bob's) and uses that information to make future predictions.

Then there are Web-based business management tools that share information and integrate with a wide variety of other business systems. Salesforce.com is probably the best-known example of a Web-based business management system that integrates with CRM tools like SAP, accounting systems like Oracle and any other internal or external data sources, like shipment tracking and customer service satisfaction.

Services like Salesforce.com analyze the many layers of data that affect sales performance. It can tell if products are being held up in shipping from the warehouse to the retail store or if sales contracts are getting caught up in legal. This helps business executives make the right adjustments to bump up their sales forecasts for the future.

For even more information about sales forecasts and related business topics, see the links on the next page.

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