Sales Forecasts…the Most Common Mistake to Avoid
During the early stages of my career I worked as a Product Manager for a division of a large corporation that placed high value on planning and forecasting. Upon receiving the assignment to develop a budget for the coming year I decided to reach out to our most experienced territory managers to ask for their sales forecasts. My first call set the tone when Lew deadpanned “My forecast is the same every year…I’m going to sell all I can.” Not a surprising answer from someone whose income was largely based on commissions, but not helpful for my purposes. I soon learned Lew was representative of many people’s view of sales forecasting, which is essentially the belief we can control our own efforts but little else so a forecast is basically just a guess and not worthy of an investment of time or effort.
Despite the perceived difficulty, it is important we forecast sales as part of an overall plan for our businesses. The process is different for established businesses than for new ventures, so this post will explore the key points for each.
Most existing businesses use history as a basis for developing a forecast, and that is a reasonable place to begin. Start by listing sales by month for the prior year, or perhaps two years, then identify any unique factors that may have influenced sales in any of those months. These might include variations resulting from internal factors such as promotions, material shortages, or staff turnover, or external events such as severe weather, road closures, customer gain/loss, or economic instability. Once you have given context to the historical numbers to adjust for these anomalies, it is time to look forward. What is the overall growth forecast for your industry? Are you aware of any competitors entering or exiting the market? Do you anticipate expanding your geographic service area? Have you, or will you, hire additional sales personnel? While not an exhaustive list, these are the types of questions you should consider to envision how the coming year may compare to recent history. Finally, always remember to consider price. If competitive pressures are forcing prices downward, revenue will decline even if the number of units sold remains constant. The reverse is also true.
Forecasting sales for a new venture requires a different approach since we lack the benefit of historical data. The most common mistake made in forecasting sales for new businesses is taking a “top down” approach, i.e. quantifying overall market potential and making a revenue forecast based on attaining a level of market share. For example, assume the market potential for the company’s planned product/service has been calculated at $200 Million. Too many aspiring entrepreneurs look at these large numbers and conclude they only need to gain one percent of the market in order to generate first year sales of $2 Million. While the math is correct, and capturing only one percent of a market may sound feasible, this thought process over-simplifies what it takes to build $2 Million in revenue.
Sales for new businesses are best forecasted using a “bottom up” approach, identifying the elements required to make a sale and determining the business’ capacity to repeat the process. Building on our example above assume the average customer in this industry will yield $5,000 in revenue, which means the business must open 400 new accounts to reach $2 Million in sales. Let us further assume that sales personnel will close 20% of the accounts they approach and that a sales person can meet with three prospects per work day. If a sales person works 250 days/year, making three calls per day and closing 20% of the prospects, the result is 150 customers, or $750,000 in sales. Hitting the sales target will require three sales people…will the new business have sufficient capital to pay three salespeople from day one?
Sales force capacity is just one factor in a bottom up approach. The key is to understand what is required to open and serve one customer, in terms of people, capital, materials, etc., and determine the business’ ability and capacity to repeat that process to build the first year customer base. This process ensures rigorous consideration of all factors impacting revenues and avoids the temptation to base the forecast on winning a small piece of a large pie.
Forecasting sales need not be a daunting process. With a logical approach and a reasonable investment of time it is possible to develop a credible sales forecast for your new or existing business.