Yes, you can manage your sales forecast assumptions. Don’t think you need to have an MBA degree or be a CPA. Don’t think it’s about sophisticated financial models or spreadsheets. I was a vice president of a market research firm for several years, doing expensive forecasts, and I saw many times that there’s nothing better than the educated guess of somebody who knows the business well. All those sophisticated techniques depend on data from the past. And the past, by itself, isn’t the best predictor of the future. You are. So let’s look at how to forecast sales, step by step.
Your sales forecast won’t accurately predict the future. We know that from the start. What you want is to lay out the sales drivers and interdependencies, to connect the dots, so that as you review plan vs. actual results every month, you can easily make course corrections.
If you think sales forecasting is hard, try running a business without a forecast. That’s much harder.
Your sales forecast is also the backbone of your business plan. People measure a business and its growth by sales, and your sales forecast sets the standard for expenses, profits and growth. The sales forecast is almost always going to be the first set of numbers you’ll track for plan vs. actual use, even if you do no other numbers.
If nothing else, just forecast your sales, track plan vs. actual results, and make corrections; that’s already business planning.
Sales Forecast Step 1: Set Your Categories
Plan how many categories of revenue you have. Look for the right level of detail. Forecasting, even though it often results in tables that look like accounting reports, doesn’t work in too much detail. For example, a restaurant ought not to forecast sales for each item on the menu, but for breakfasts, lunches, dinners, and drinks. And a bookstore ought not to forecast sales by book, and not even by topic or author, but rather hard cover, soft cover, magazines, and maybe main sections (such as fiction, non-fiction, travel, etc.) if that works. For example, the bicycle retail store doesn’t forecast by each type of bike, or part, or item of clothing. It summarizes by the product lines as shown in the illustration that follows here:
LivePlan guides you through this process. You name your category and then forecast as shown below. First, though, I recommend defining all the categories.
LivePlan gives you the option of forecasting amounts per month or forecasting units and average prices per item. I strongly recommend the forecast by units, which is what I show here. Projecting unit sales and unit prices gives you more information to work with later, when you evaluate actual results compared to plan. You’ll be able to determine to what extent the difference between plan and actual is the result of a difference in units, or a difference in price.
At first glance, service businesses don’t sell units. However, attorneys and accountants bill by the hour, taxi drivers charge by the trip, and so forth. Try to think of your sales in units. If you can’t, then don’t; but you still need a sales forecast.
The illustration here below shows how LivePlan gives you a choice of forecasting by units or not. The options include revenue only, unit sales, or recurring charges (such as a monthly subscription). It’s your choice. I recommend unit sales and that’s what I use for the bicycle store examples in this book.
Step 2: Estimate Units
After you choose to forecast by units, LivePlan guides you through entering the units for each of the next 12 months, plus annually for the second and third years.
But how do you know what numbers to put into your sales forecast? The math may be simple, yes, but this is predicting the future; and humans don’t do that well. Don’t try to guess the future accurately for months in advance. Instead, aim for making clear assumptions and understanding what drives sales, such as web traffic and conversions, in one example, or the direct sales pipeline and leads, in another. And you review results every month, and revise your forecast. Your educated guesses become more accurate over time.
Timing of sales
Your sales are supposed to refer to when the ownership changes hands (for products) or when the service is performed (for services). It isn’t a sale when it is ordered, or promised, or even when it’s contracted. With proper accrual accounting, it is a sale even if it hasn’t been paid for. With so-called cash-based accounting, by the way, it isn’t a sale until it’s paid for. Accrual is better because it gives you a more accurate picture, unless you’re very small and do all your business, both buying and selling, with cash only. I know that seems simple, but it’s surprising how many people decide to do something different. And the penalty of doing things differently is that then you don’t match the standard, and the bankers, analysts, and investors can’t tell what you meant.
Use experience and past results
Experience in the field is a huge advantage. In the example above, Garrett the bike store owner has ample experience with past sales. He doesn’t know accounting or technical forecasting, but he knows his bicycle store and the bicycle business. He’s aware of changes in the market, and his own store’s promotions, and other factors that business owners know. He’s comfortable making educated guesses. In following example, the café startup entrepreneur makes guesses based on her experience as an employee.
Use past results as a guide. Use results from the recent past if your business has them. Start a forecast by putting last year’s numbers into next year’s forecast, and then focus on what might be different this year from next. Do you have new opportunities that will make sales grow? New marketing activities, promotions? Then increase the forecast. New competition, and new problems? Nobody wants to forecast decreasing sales, but if that’s likely, you need to deal with it by cutting costs or changing your focus.
Yes you can forecast a new business or new product
What? You say you can’t forecast because your business or product is new? Join the club. Lots of people start new businesses, or new groups or divisions or products or territories within existing businesses, and can’t turn to existing data to forecast the future.
Think of the weather experts doing a 10-day forecast. Of course they don’t know the future, but they have some relevant information and they have some experience in the field. They look at weather drivers such as high and low pressure areas, wind directions, cloud formations, storms gathering elsewhere. They consider past experience, so they know how these same factors have generally behaved in the past. And they make educated guesses. When they project a high of 85 and low of 55 tomorrow, those are educated guesses.
You do the same thing with your new business or new product forecast that the experts do with the weather. You can get what data is available on factors that drive your sales, equivalent to air pressure and wind speeds and cloud formations. For example:
- To forecast sales for a new restaurant (there’s a detailed example in a following section), first draw a map of tables and chairs and then estimate how many meals per mealtime at capacity, and in the beginning. It’s not a random number; it’s a matter of how many people come in. So a restaurant that seats 36 people at a time might assume it can sell a maximum of 50 lunches when it is absolutely jammed, with some people eating early and some late for their lunch hours. And maybe that’s just 20 lunches per day the first month, then 25 the second month, and so on. Apply some reasonable assumption to a month, and you have some idea.
- To forecast sales for a new mobile app, you might get data from the Apple and Android mobile app stores about average downloads for different apps. And a good web search might reveal some anecdotal evidence, blog posts and news stories perhaps, about the ramp-up of existing apps that were successful. Get those numbers and think about how your case might be different. And maybe you drive downloads with a website, so you can predict traffic on your website from past experience and then assume a percentage of web visitors who will download the app.
So you take the information related to what I’m calling sales drivers, and apply common sense to it, human judgment, and then make your educated guesses. As more information becomes available — like the first month’s sales, for example – you add that into the mix, and revise or not, depending on how well it matches your expectations. It’s not a one-time forecast that you have to live with as the months go by. It’s all part of the lean planning process.
Sales forecast depends on product/service and marketing
Never think of your sales forecast in a vacuum. It flows from the strategic action plans with their assumptions, milestones and metrics. Your marketing milestones affect your sales. Your business offering milestones affect your sales. When you change milestones — and you will, because all business plans change — you should change your sales forecast to match.
Step 3: Estimate Average Prices
The next step is a simple estimate of average unit prices. This is planning, not accounting, so keep it simple. You’re working with averages, summary, and aggregation. In this bicycle store example, the average price of a bicycle is $500. That’s one number to summarize all bicycle transactions. You’ll be able to adjust over time. This example uses one average price for the entire forecast. LivePlan does allow you, as an option, to have varying prices over time. The bicycle store doesn’t need that.
Step 4: Estimate Average Direct Costs
Now estimate direct costs, also called COGS, or cost of goods sold, or unit costs. These are costs that the business incurs only in delivering what it sells. In a bicycle shop, it’s what is paid for the bicycles, accessories, clothes, and parts that it sells. For a bookstore, it’s what the store paid for the books it sells. For a taxi business, it’s the gasoline and routine maintenance. Direct costs are useful for comparison basis.
LivePlan gives you some obvious choices for how to estimate those direct costs. In this bicycle store example, the owner chooses 69 percent for direct costs.
When in doubt, LivePlan can help you with these estimates. It includes a database of benchmarks that offer industry standards for key numbers. For example, the illustration below shows benchmarks for sporting goods retail, which is roughly what applies to the bicycle store.
Fill in All the Assumptions and You Have a Sales Forecast
LivePlan guides you through these assumptions for each of your rows of sales, and from there generates a complete sales forecast as shown here for the sample company.
LivePlan Reality Check
Although we don’t discuss Gross Margin until Chapter 17 on Profit and Loss, LivePlan includes a reality check on Gross Margin that can help you with your sales forecast. Gross Margin is sales less direct costs. By the time Garrett finished his LivePlan sales forecast shown above, LivePlan was already calculating the Gross Margin for him – in this case it’s 43%.
And as Garrett does that, he can turn to the LivePlan built-in benchmarks to see where his estimates fall: