How to forecast sales more accurately
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. Forecasting 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.
, 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. The Proposition Pricing 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? What is the competitive landscape like, i.
, are there barriers to entry/ attractive alternatives? What is the turnover of a close competitor and how profitable are they? Macro Environmental Trends Competition 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., alcohol and tobacco? Will a growing environmental consciousness affect demand levels? 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? Seasonal Characteristics Substitutes 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., price, features, service, etc.? The Market Marketing What is the market demand for the product category (i., 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.
How do you make 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.