How do businesses forecast sales?
Running a business without a sales forecast is a bit like setting off on an expedition without a map or a compass. You know where you want to get to, but without a way of charting your course, it’s impossible to know if you are moving in the right direction.
A sales forecast acts as your compass, providing you with a wealth of information so you can decide on the best course of action to take. Decisions like whether to expand production, pause recruitment, or increasing marketing spend are much easier and more accurate when you know the level of sales performance expected within a set time period.
If you aren’t familiar with sales forecasting or don’t know how to create a sales forecast, we have created a guide that covers everything that you need to know to make sure you’re following the right path.
Putting together a sales forecast doesn't have to be a difficult process. Providing you have a thorough understanding of how your business operates then you can create a template to use time and time again.
What is a sales forecast?
A sales forecast is a projection of an organisation’s future sales performance calculated over a specified period of time. This is usually monthly, quarterly or yearly. The forecast estimates future revenue based on a set of factors: typically a combination of historic sales data, industry and market trends, and company growth or expansion plans.
For example, let’s say you run a business that sells shoes. To create your sales forecast you would start by pulling together your entire shoe sales history since you began trading. Next, you would account for any sales assumptions (variables) such as an increase or decrease in sales depending on the season, or if there are any plans to expand your product range or increase your level of manufacturing production. If you predict that over the next 12 months you will sell 10,000 items at an average price per item of £20, then your sales forecast for that 12 month period would be £200,000.
You may have noticed that when talking about sales forecasting we’ve used the terms ‘projection’ and ‘estimate’. That’s because it’s impossible for a sales forecast to be 100% accurate; there are too many variables that will result in your actual revenue differing from your forecast.
However, that’s not to say that a sales forecast is a waste of time. If you use accurate data, account for any relevant sales assumptions, and continually re-visit, review and update the figures, then a forecast can be extremely valuable to ensure you can plan for the future.
Is a sales forecast worth the effort?
An accurate sales forecast can ultimately be the difference between success and failure for a business. If you don’t have an idea of future performance it makes it very difficult to make informed decisions in the present.
If you could spot a market that was going to see explosive growth in the next 6 months, you would want to do everything you could to align your operations, strengthen your team and build a strategy to capitalise on that opportunity. Similarly, if demand for one of your products is falling month on month you wouldn’t want to keep manufacturing the same number of items only for them to be sitting on shelves accumulating dust in your warehouse.
From business owners to HR and hiring teams, a sales forecast can offer value to everyone within a company. Here are just some of the ways it can help:
Make budgeting decisions
Being aware of the level of demand for your services or products is useful for all areas of your company. If the forecast shows an increase in sales, then you may need to expand production or hire new staff to be able to hit your new targets. If sales are predicted to fall, it would be sensible to keep a tight rein on the purse strings, such as implementing a hiring freeze or cutting back on marketing spend.
Improvement in company morale and performance
Sales forecasting can shine a light on areas of the business that could benefit from additional investment in staff or highlight resources and processes that may be experiencing unwanted delays. The knock-on effect of this can potentially lead to a strain on employees, increased pressure to meet targets and dissatisfaction with their jobs. Aligning business goals and targets with the whole organisation can avoid this happening.
Better planning and decision making
A successful business is typically very good at adapting to change: both internal and external. Sales forecasting helps you spot opportunities and potential problems that might arise, allowing you to refine or re-position your strategy. Having oversight of all of the areas of your business can help you:
- Grow your customer base
- Plan for new competitors in the marketplace
- Improve conversion rates
- Reduce delays
How to create a sales forecast
Now that we have won you over to the merits of sales forecasting, here’s how to get started:
1. Top-down or bottom-up forecasting?
The first step is to decide which approach to use. There are two main methodologies for a sales forecast: top-down and bottom-up.
A top-down forecast starts by calculating the total size of a given market and working out what slice of the customer base a company can ‘win’. For example, if the total size of the UK shoe industry is £9 billion, a new business might estimate that they can claim 0.1% of the market, worth £9 million.
A bottom-up forecast begins with the business and the products or services that it offers. This approach is based on how many sales a company can make - which could depend on the number of customers it currently has, how quickly they can manufacture products, or how well they can attract new customers. For example, if a business has a product that sells for £20 to 10,000 customers per month, and they are confident they can meet demand, they would forecast sales of £200,000 per month or £2.4 million per year.
Both methodologies have their pros and cons so it’s important to take the time to decide which approach is best for you. To begin with, we would recommend running both in your forecast to validate that neither of your estimates is wildly out of line with the other. If they are, then you may need to review your figures and see if the targeted results really are achievable.
2. Decide which products or services you are going to include
If you are a small business, which only sells a limited range of products, it makes sense to include everything in your forecast. Large businesses, with hundreds of products lines or services, may want to separate items into categories and run several forecasts in order to make it easier to manage.
On your template, under each reporting cycle (weekly or monthly), you'll want to record the price per item and the number of units sold. This will allow you to work out the total forecasted gross revenue for each item. You may also want to add in the cost of goods (COGS) so you can calculate the forecasted net revenue.
3. Choose how to calculate and forecast your sales growth
If you are an established business, you can use your historic sales data to project your market growth and future sales. Work out your month-on-month sales growth and combine this with economic and market trends to forecast your future revenue over a given time period. We recommend setting out month-by-month for the first 12 months, and then annually for the next three years.
But what if you are launching a completely new product or running a start-up with no sales history? Fear not, there are other ways to carry out your forecast. As we mentioned earlier, the top-down approach is based on analysing the market in your industry and estimating the share that you can realistically expect to win.
If using this approach, it's important to conduct thorough research and eliminate as much guesswork as possible. Look at your competitors and analyse their financial performance; if any of them are recently established companies take a deep dive into their figures and track their sales growth from launch. Speak to consumers to understand their buying habits, or send out surveys to potential customers to see how your products compare to your competitors.
4. Build in sales assumptions
As well as predicting your sales growth based on historical data or market share, you also need to factor in internal and external variables in the form of sales assumptions. These are events or trends - sometimes outside of your control - that could affect future sales performance.
Sales assumptions include:
- Seasonality: Is demand for a product or service higher or lower than at other times of the year. A good example of this is an ice cream vendor. They could expect sales to peak in the summer months and drop off in winter.
- Regulatory changes: Would the introduction of new laws or legislations affect how you manufacture/distribute/market your product or service? What would the impact be on sales?
- Economic changes: What impact would changes to inflation rates, an increase in corporate tax, or a global recession mean for your business?
- Marketing budget: How much are you planning to spend on your marketing/advertising over a set period of time or for a specific campaign. How many new customers can you expect to attract?
5. Track, review and update
The process doesn't end after you've created your forecast. As we mentioned earlier, you want your sales projection to be as accurate as possible. Keep your forecast up to date with the latest sales data and constantly review the information to see if you are on track to achieve your goals. Does the data suggest that you need to change your strategy or funnel additional funds into a specific area of the business in order to meet customer demand?
In conclusion, forecasting sales isn't difficult or unnecessarily time-consuming, and it will ensure you are heading in the right direction. Remember that you can create your forecast based on how big the market is, or how much you sell your products for, and include everything you know about your customers’ buying habits. Once you have set up your sales forecast, you can compare it to actual sales on a monthly basis, and tweak your assumptions as you go along.
Given how quickly the business landscape can shift, it makes sense to have tools like sales forecasting at your disposal that can help you make fast, accurate and informed decisions.