SCORE Small Business Blog

The Sales Forecast, Part 4 of 6
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Your sales forecast is fundamental to a realistic business plan. It determines profitability. The simplest sales forecast is “units sold per time period,” usually per month. If you have more than one product type, you will want to forecast sales of each type separately.

How Do You Estimate Unit Sales For The Future?

Most companies forecast sales by considering several methods, blending the results into something they trust. Here are several common methods:

1. Trended: assumes past sales trends will continue

2. Bottom-Up: Ask your sale force and distributors

3. Top-Down: Make your own forecast per salesperson or distributor

4. Market Share: Estimate your share of the market for the year, and then spread those sales across the months considering industry seasonality and your own growth trend.

5. Pace of Growth: Estimate your capacity at business maturity, and gradually grow sales to that point.

6. Customer-Driven: Estimate sales per customer per month. Then estimate a reasonable number of new customers per week or month based on the marketing programs you expect to use. Add them to a spreadsheet row for your new customer additions for each month, and continue to show them in your customer base for as many months as you estimated they would continue to use your services. Remove them when that expires. Customers x sales/customer = sales.

Reality Test

Forecasts always need some kind of external benchmark to provide a reality test. For example, you could use the sales funnel (see Sales Funnel) to test the practicality of a bottom-up forecast.

Consider the sales cycle as well. The sales cycle estimates the time between the first customer contact and closing the sale. It may be a few minutes, or six months. If a salesperson is going to make 4 sales in January, and it is now November, how many accounts should he already be in contact with, based on the normal percentage of contacts converting to sales? Is he on schedule, or will he miss the target?

But There’s More!

Once you have a forecast of units sold, the hardest work is done, but you have delivered only a fraction of the information needed! With a little more effort, using either company data or assumptions already in your business plan thinking, you can provide a forecast that is really useful for projecting expenses, profits, and cash flow. You need to forecast each of these in your business plan anyway.

For the most useful sales forecast, the other estimates needed are:

  • Average price per product per month (avg. price times units = revenue). This estimate uses the list price minus expected discounts.
  • Sales commission is part of your variable costs. Estimate it as a percentage of revenue.
  • Variable costs per product (variable cost per unit times units = variable expenses). Subtract these from revenue to find gross or contribution margin. Use that to calculate breakeven point, and to verify that prices are high enough.
  • The cash cycle tells you when cash started to be spent before the sale, such as for raw materials and labor, and after the sale for commissions and shipping. It also tells you when cash arrives as payments after the sale. For example, you may order raw materials 2 months before a sale, receive them in two weeks, and pay for them 30 days after that. Thus cash is going out two weeks before the sale. Cash is received at the time of sale in some businesses, or 30 to 60 days later for those companies who use invoicing.

Providing for cash expenses before receiving cash payments requires “working capital,” a cash cushion. When it disappears, the business either fails or goes deeper into debt. So the cash flow forecast is probably the most important forecast a small business can make. A short cash cycle means less working capital is needed and success is more likely.

How Do You Capture All This Thinking Into Documents?

First, write down your assumptions as you make the unit sales forecast, and as you make the other estimates (average price, sales commission, variable costs, cash cycle). A list of key assumptions goes in the Financial section of your Business Plan, and this is a good time to start it.

Second, enter your unchanging sales commission percentage and variable costs per product into Excel cells, and reference these cells in the formulas used to calculate revenue, sales commissions, and variable costs.

Third, set up a new set of rows for cash flow calculations. Assume all sales occur mid-month. Label a row for revenue, a row for sales commission, and a row for each of the variable costs. For each cell in these rows, create a formula to find the cash effect occurring that month due to unit sales in any month. For example, using the previous example in the cash cycle definition:

-          June variable costs = July unit sales for the product x variable cost for that product (supplies paid for 2 weeks before sale)

-          September revenue = July unit sales for the product x July price for that product (invoice paid 60 days after sale).

Why Not Just Use Business Plan Software?

Of course, you could also enter your estimates into packaged software such as Business Plan Pro. Then all your numbers would cross-foot, but you would not know how they were calculated because you let the software do it! If you don’t know how they are calculated, you will have a hard time managing them. In a small business where “cash is king,” it’s better to know your numbers intimately if you want your business to succeed.

Tom GrayMentor, SCORE Fox Valley
Tom helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), and a SCORE Mentor.
www.SCOREFoxValley.org | SCORE Mentors | @SCOREFoxValley | More from Tom

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