New entrepreneurs frequently ask me for advice about forecasting their sales. These entrepreneurs are always optimistic about the future of their new company. However, when it comes to the details, most aren’t sure how to predict future sales and how much money they’re going to make.
It’s an intimidating task, looking into the future. The good thing is, none of us are fortune tellers and none of us know any more about your new business than you do. (If you do happen to be able to see into the future, please just skip the whole startup thing and go play the stock market. It’ll be much easier and make you richer!)
So, my advice is always to just take a deep breath and relax. You’re as well equipped as everyone else to put together a credible, reasonably accurate forecast. Let’s dive right in and figure it out.
What is sales forecasting?
Sales forecasting is the process of estimating future sales with the goal of better informing your decisions. A forecast is typically based on any combination of past sales data, industry benchmarks, or economic trends. It’s a method designed to help you better manage your workforce, ash flow, and any other resources that may affect revenue and sales
It’s typically easier for established businesses to create more accurate sales forecasts based on previous sales data. Newer businesses, on the other hand, will have to rely on market research, competitive benchmarks, and other forms of interest to establish a baseline for sales numbers.
Why is sales forecasting important?
Your sales forecast is the foundation of the financial story that you are creating for your business. Once you have your sales forecast complete, you’ll be able to easily create your profit and loss statement, cash flow statement, and balance sheet.
Sales forecasts help you set goals
But beyond just setting the stage for a complete financial forecast, your sales forecast is really all about setting goals for your company. You’re looking to answer questions like:
What do you hope to achieve in the next month? Year? 5-years?
How many customers do you hope to have next month and next year?
How much will each customer hopefully spend with your company?
Your sales forecast will help you answer all of these questions and potentially any others that involve the future of your business.
Sales forecasts inform investors
Having a solid sales forecast also provides a picture of your performance and performance milestones for potential investors. Like you, they want to be sure you have established goals and a firm trajectory for your business laid out. The more detailed, organized, and up-to-date your forecast is, the better you explain the position of your business to third parties and even employees.
How to use your sales forecast for budgeting
Your sales forecast is also your guide to how much you should be spending. Assuming you want to run a profitable business, you’ll use your sales forecast to guide what you should be spending on marketing to acquire new customers and how much you should be spending on operations and administration.
Now, you don’t always need to be profitable, especially if you are trying to expand aggressively. But, you’ll eventually need your expenses to be less than your sales in order to turn a profit.
How detailed should your forecast be?
When you’re forecasting your sales, the first thing you should do is figure out what you should create a forecast for. You don’t want want to be too generic and just forecast sales for your entire company. On the other hand, you don’t want to create a forecast for every individual product or service that you sell.
For example, if you’re starting a restaurant, you don’t want to create forecasts for each item on the menu. Instead, you should focus on broader categories like lunch, dinner, and drinks. If you’re starting a clothing shop, forecast the key categories of clothing that you sell, like outerwear, casual wear, and so on.
You’ll probably want between three to ten categories covering the types of sales that you do. More than ten is going to be a lot of work to forecast and fewer than three probably means that you haven’t divided things up quite enough.
You really can’t get this wrong. After all, it’s just forecasting and you can always come back and adjust your categories later. Just pick a few to get started and move on.
Which forecasting model is best? Top-down or bottom-up?
Before they have much historical sales data, lots of startups make this mistake—and it’s a big one. They forecast “from the top down.” What that means is that they figure out the total size of the market (TAM, or total addressable market) and then decide that they will capture a small percentage of that total market.
For example, in 2015, more than 1.4 billion smartphones were sold worldwide. It’s pretty tempting for a startup to say that they’re going to get 1 percent of that total market. After all, 1 percent is such a tiny little number, it’s got to be believable, right?
The problem is that this kind of guessing is not based on any kind of reality. Sure, it looks like it might be credible on the surface, but you have to dig deeper. What’s driving those sales? How are people finding out about this new smartphone company? Of the people that find out about the new company, how many are going to buy?
So, instead of forecasting “from the top-down,” do a “bottom-up” forecast. Just like the name suggests, bottom-up forecasting is more of an educated guess, starting at the bottom and working up to a forecast.
Start by thinking about how many potential customers you might be able to make contact with; this could be through advertising, sales calls, or other marketing methods. This is your SOM (your “share of the market”), the subset of your 1 percent of the market that you will realistically reach—particularly in the first few years of your business. This is your target market.
Of the people you can reach, how many do you think you’ll be able to bring in the door or get onto your website? And finally, of the people that come in the door, get on the phone, or visit your site, how many will buy?
Here’s an example:
10,000 people see my company’s ad online
1,000 people click from the ad to my website
100 people end up making a purchase
Obviously, these are all nice round numbers, but it should give you an idea of how bottom-up forecasting works.
The last step of the bottom-up forecasting method is to think about the average amount that each of those 100 people in our example ends up spending. On average, do they spend $20? $100? It’s O.K. to guess here, and the best way to refine your guess is to go out and talk to your potential customers and interview them. You’ll be surprised how accurate a number you can get with a few simple interviews.
How to create a sales forecast
Keep in mind that your sales forecast is an estimate of the number of goods and services you believe you can sell over a period of time. This will also include the cost to produce and sell those goods and services, as well as the estimated profit you’ll come away with.
We’ll dive into specific methods and, assumptions, and questions you’ll need to ask in order to build a viable sales forecast. But to start, here are the general steps you’ll need to take to create a sales forecast:
List out the goods and services you sell
Estimate how much of each you expect to sell
Define the unit price or dollar value of each good or service sold
Multiply the number sold by the price
Determine how much it will cost to produce and sell each good or service
Multiply this cost by the estimated sales volume
Subtract the total cost from the total sales
This is a super basic rundown of what is included in your sales forecast to give you an idea of what to expect. For example, you may find the need to aggregate similar items into unified categories, if you sell a large variety of items. And if at all possible, try to keep your forecasted items grouped similarly to how they appear on your accounting statements to make updates easier.
Now let’s dive into some specific elements of your forecast you’ll need to define ahead of time.
Should you forecast in units or dollars?
Let’s start by talking about “unit” sales.
A “unit” is simply a stand-in for whatever it is that you are selling. A single lunch at a restaurant would be a unit. An hour of consulting work is also a unit. The word “unit” is just a generic way to talk about whatever it is that you are selling.
Now that’s out of the way, let’s talk about why you should forecast by units.
Units help you think about the number of products, hours, meals, and so on, that you are selling. It’s easier to think about sales this way rather than to think just in dollars (or yen, or pounds, or rand, etc.).
With a dollar-based forecast, you are only thinking about the total amount of money that you’ll make in a given month, rather than the details of the number of units that you are selling and the average price you are selling each unit for.
To forecast by units, you predict how many units you’re going to sell each month—using the bottom-up method of course. Then, you figure out what the average price is going to be for each unit. Multiply those two numbers together and you have the total sales you plan on making each month.
For example, if you plan on selling 1,000 units at $20 each, you’ll make $20,000.
When you forecast by units, you have a couple of different variables to play with: What if I’m able to sell more units? What if I raise or lower my prices?
Also, there’s another benefit: At the end of a month of sales, I can look back at my forecast and see how I did compared to the forecast in greater detail. Did I meet my goals because I sold more units? Or did I sell for a higher price than I thought I would? This level of detail helps you guide your business and grow it moving forward.
Sales forecast assumptions
One thing to remember is that your sales forecast is built on assumptions. You’re not predicting the future, but aggregating information to help define your future outlook. These assumptions are always changing, meaning that you’ll need to have a pulse on the following:
Market conditions
Having a general understanding of the macro effects on your business can help you better predict overall growth. A growing or shrinking market can either provide a low or high ceiling for potential sales increases. So, you need to understand how your business can react to any changes.
What does the broader market look like? Is the economy slowing or growing? Is the industry you operate in seeing an influx of competition? Maybe there’s a labor or material shortage? Are there new customers you now have access to?
Products and services
You may find yourself making regular changes to your products and services. This can be sales factors that impact the customer, or production factors that impact the overall cost.
Are you making any changes or updates to current offerings? Are you launching a new product or service that compliments or disrupts your existing sales? Are you adjusting prices or sales channels? Are you able to decrease the cost of production? Or are expenses rising due to material, labor, or other production costs?
Seasonality
Depending on what you’re selling, you may find dips or increases in sales at specific times during the year. This seasonality may have to do with the weather, holidays, product/feature releases, or a number of other predictable factors.
If you have been operating for a while, you can likely look at your accounting data to identify any trends. If you’re a new business look to your competitors to see how they act during specific times of the year to help you identify these trends earlier on.
Marketing efforts
How much you spend on marketing, and even your messaging may have an impact on your overall sales. Make sure that you connect any performance changes to marketing efforts that may affect your performance.
Are you launching a new marketing campaign? Are you spending more or less on advertising? Are you adjusting your targeting for digital ads? Are you branching out or removing specific marketing channels from your overall strategy?
Regulatory changes
You may find that specific laws or regulations directly impact your industry. It’s difficult to anticipate what legislation will provide a negative or positive impact, and just how often this type of regulatory change may occur. The best thing you can do is keep your ear to the ground, and be ready to adjust expenses or sales when any changes appear to make traction.
How far forward should you forecast?
I recommend that you forecast monthly for 12 months into the future and then just develop an annual sales forecast for another three to five years.
The further your forecast into the future, the less you’re going to know and the less benefit it’s going to have for you. After all, the world is going to change, your business is going to change, and you’ll be updating your forecast to reflect those changes.
12 months from now is far enough into the future to guess. You’ll have to update your forecasts regularly with actual performance to help keep them accurate.
And don’t forget, all forecasts are wrong—and that’s O.K. Your forecast is just your best guess at what’s going to happen. As you learn more about your business and your customers, you can change and adjust your forecast. It’s not set in stone.
Why using visuals will make forecasting easier
My final word of advice is to make sure that you graph your monthly sales with a chart.
A chart will make it easy to see how your sales might dip during a slow period of the year and then grow again during your peak season. A chart will also highlight potentially unreasonable guesses at your sales growth. If for example, you show a big jump in sales from one month to the next, you should be able to back this up with a strategy that’s going to deliver those sales.
Adjust your forecasts based on actual results
Your sales forecast isn’t done when you start sharing it with lenders and investors. Instead, smart businesses use their sales forecast to measure their progress and ensure that they’re on the right track. Their sales forecast becomes a live forecast. An up-to-date management tool that helps them run their business better.
The easiest way to convert your sales forecast into a management tool is to have a monthly financial review meeting where you look at your business’s finances. You shouldn’t just look at your accounting system, though. You should compare the numbers from your accounting software to your forecast and see if you’re on track.
Are you exceeding your goals? Or maybe you’re falling a little bit short. Either way, knowing if you’re meeting your goals or not will help you determine if you need to make some shifts in strategy. This way, your business numbers drive your strategy.
Forecasting is easier with LivePlan
Tools like LivePlan can help with this. LivePlan uses a smart dashboard to automatically compare your forecast to your numbers from your accounting system—no cutting and pasting or complicated spreadsheets required. And with LivePlan’s LiveForecast feature, you can update the forecasts within your Profit and Loss Statement, with the push of a button.
This allows you to spend less time updating and more time analyzing performance to make better decisions. In fact, the LiveForecast feature allows you to expand the details of your performance and identify the variance in performance within your statements. You’ll know your current cash position and the impact on projected year-end totals at a glance. It provides you with enough information to then explore the dashboard with questions and potential steps in mind.
Sales forecasting isn’t as difficult as you think
Just remember that sales forecasting doesn’t have to be hard. Anyone can do it and you, as an entrepreneur, are the most qualified to do it for your business. You know your customers, and you know your market, so you can forecast your sales.
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