Forecasting sales is an important part of business planning. You can use the information to develop your cashflow forecast and budget effectively. This section looks at the different methods of forecasting, shows you how to create your sales forecast and how to calculate your break-even point.
2. Forecasting Sales
Forecasting sales is an important part of business planning. Not only can you use the information to develop your cashflow forecast and budget effectively, you can also set sales goals for what you need to achieve on a daily, weekly or monthly basis.
Sales forecasting is usually done on an annual basis.
There are 3 basic methods of forecasting sales for new start businesses:
- market-based – based on the results of your market research
- resource-based – based on how much you can produce
- value-based – based on what you have to sell to make a profit
3. Market-based forecasting
Your market research will have given you valuable information about who your customers are, how many there are, how much they are likely to spend and how often they are likely to buy. You can use this information to begin estimating the number of sales you could make per month.
You also need to look at what your competitors are doing. How do your estimates stack up against a similar sized business?
Remember to take note of other factors that influence sales such as seasonality, trends and fashion, price changes and the amount of disposable income available, as well as what competitors are doing.
Be realistic with your estimates.
For example, if you are opening a bed and breakfast with capacity for 8 people and your research says potential customers would spend on average £30 each per visit, you can estimate your maximum sales to be £240 per day (8 people x £30 each).
However, this is a maximum estimate if every bed is filled and every customer spends £30.
Now look at your competitors – how full are their B&Bs and how does this change on different days of the week?
If you estimate they are full 75% of the time, amend your estimate to £180 (£240 x 75%).
You may also want to adjust this figure for holiday times and summer or winter to get a more accurate forecast.
4. Resource-based forecasting
This method of sales forecasting looks at how the limitations on resources in your business may influence the sales you are able to achieve. These resources will include money, equipment, time and people.
In our previous example, the B&B owner is restricted by the number of beds, their capacity to handle 8 guests, and when they are open.
If you run a manufacturing business, how much you can produce is dictated by how long you can run your machinery, how many staff you have and how much raw materials you can afford to buy.
If your business provides a service, you are limited by the amount of productive time you can work.
Look at the resource limitations in your business and take these into account when putting your sales forecast together.
5. Value-based forecasting
It is important to know and understand the figures in your business. This method of sales forecasting looks at how much you need to sell in order to cover all your costs, including your overheads. This is your breakeven point.
If your sales fall below your break-even point, your business loses money and fails to make a profit.
6. Calculating your Break-even point
The break-even point is the point at which your costs and your income are equal. Anything you sell above break-even generates profit for you.
To calculate your break-even point, you need to know:
1. Total fixed costs or overheads for the year.
2. Direct costs associated with producing each unit.
3. Expected selling price per unit.
Total Fixed Costs: £10,000
Direct Costs per Unit: £2
Unit Selling Price: £6
Work out the contribution each unit makes to the total fixed costs by subtracting the Direct Costs per Unit (£2) from the Unit Selling Price (£6).
Selling Price – Direct Costs per unit £6 - £2 = £4
Next, divide the total fixed costs (£10,000) by the contribution per unit (£4). This calculation will provide you with the number of units required to be sold in order to break even:
Fixed Costs ÷ Unit contribution = units (Break-even point)
£10,000 ÷ £4 = 2,500 units (Break-even point)
For service-based businesses, use selling price per hour instead of units, and deduct any direct costs per hour.
Using Break-even point to forecast sales
In our example, the business needs to sell 2,500 units to break-even.
If they produce more than 2,500 units, they make a profit, less than 2,500 units and they make a loss.
The sales forecast needs to be higher than 2,500 units to make a profit.
Knowing your break-even point helps you analyse in detail what you have to sell and means you can put plans in place to achieve it.
In this example, if you assume there are 250 sales days per year (5 days per week over 50 weeks), you need to be selling 10 units every day to break-even. You can now assess how realistic this is.
7. Creating your sales forecast
A sales forecast needs to be as accurate and reliable as possible. It is usually a balance using all 3 methods highlighted in this module. It should be your best prediction of what may happen.
If you underestimate your sales, you will not be able to cover your costs. If you overestimate, you may not have enough working capital to cover your cash requirements.
Many different factors can influence sales. For example, the seasons, holidays, weather, special events, fashion, competitive activity, sales promotions, prices, production capacity and payment terms. Although you do not have control over some of these, there are 2 areas that you must consider.
- start-up sales – it is highly unlikely that you will start making sales from day 1. Be realistic when you put your sales forecast together. Estimate how long it will take you to win your first customer and at what rate the business will build
- seasonality – think carefully about how the time of the year will affect your business. This is different for each type of business. For example, a plumber is likely to have more emergency work in the winter and relatively slow business in the summer. A beautician, on the other hand, can expect more pedicures in the summer and more manicures around holiday periods. Make sure you factor seasonality into your sales forecast
The information in your sales forecast can be used to compile your cashflow forecast. Refer to your sales forecast regularly and compare your actual sales with your forecast. This way you can make sure you don’t overspend and can be ready to respond quickly if necessary. It’s a good idea to create a sales graph as a visual reminder of your performance.
Use this creating your sales forecast exercise (MS Word 12kb) to work out an example sales forecast. You can use it as a template for your own business.