Sales forecasting is especially difficult when you don’t have any previous sales history to guide you, as is the case when you’re working on preparing cash flow projections as part of writing a business plan for a new venture. Here, Terry Elliott provides a detailed explanation of how to do forecasting using three common sales forecasting methods.

Note that there are many ways to estimate sales revenues for the purposes of sales forecasting, but if you plan to work with a bank for financing or are looking for angel investors for your business, you will want to approach your sales forecast from a few different angles to ensure that you’ve thoroughly thought through your numbers, and so that you (and they) will have more confidence in the forecast.

How to Forecast Sales

Method #1

For a retail business with a brick-and-mortar location, for example, what is the average sales volume per square foot for similar stores in similar locations and similar size? Whatever your particular business might be, look for comparable companies and use their average historical sales figures to lay the basis for your firm’s sales forecast.

This isn’t the final answer for adequate sales forecasting, since the comparable company sales figure represents an established business, and a new business won’t hit that target for perhaps a year. But this approach is far more scientific than something like a general two 2 percent figure based on local household incomes.

Method #2

For your specific location, how many households needing your goods live within say, one mile? How much will they spend on these items annually, and what percentage of their spending will you get, compared to your competitors? Do the same analysis for areas within five miles, using lower sales forecast figures, using distances that make sense for your location. For example:

Method #3

If your business offers, for instance, three types of goods plus two types of extra cost services, estimate sales revenues for each of the five product/service lines. Make an estimate of where you think you’ll be in six months (such as “we should be selling five of these items a day, plus three of these, plus two of these”) and calculate the gross sales per day. Then multiply by 30 for the month.

Now scale proportionately from month one to month six; that is, build up from no sales (or few sales) in the first month to your six-month forecasted sales level. For example:

Now carry the forecast out from months six through 12 for a complete annual forecast.

Don’t Just Do One Sales Forecast

Instead of forecasting annual sales as a single figure, use one or two of the sales forecasting methods above and generate three figures: pessimistic, optimistic, and realistic.

Work with figures on a monthly basis, since depending on your business, there could be huge variations by month due to various factors, including seasonality. Some retail firms do 50 percent of their gross sales around Christmas, from the end of October to the end of December, and barely get by from June through August of each year.

Estimate Your Costs

A sales forecast should also include the firm’s direct costs so that profits can be estimated, for example:

Direct costs vary by product, business, and industry:

• For a reseller of goods, the direct cost of each item sold (also known as the cost of goods sold or COGS) is typically the wholesale price (plus shipping if applicable)
• For a manufacturer, direct costs include raw materials, labor, etc.
• For a service business, the direct costs are mainly salaries and expenses

Put in your expenses by month, including big purchases by season (or however you buy materials/goods). Remember, you may buy materials or inventory in say, July, for Christmas, yet not get all of your receipts until 45 days after Christmas. There can be big cash flow implications. Also, will you be buying vehicles? Capital equipment? Make sure to show depreciation expense. If significant, other items such as bad debts and credit card interest and other expenses for items purchased by credit card can also be included.

Taking a Sales Forecast to the Bank

If you’re going to a bank for financing, be prepared to answer questions such as:

• Have you made an allowance for a reserve cash account, for your slow months, but also in case you have to quickly replace a vehicle or equipment?
• You intend to charge x dollars for your product, but how do you respond if your competition cuts the price by 33 percent and still makes a profit?
• How will you grow your business specifically? By selling more to existing customers, selling existing products to new customers, selling new products to existing customers and selling new products in order to attract new customers? Potential lenders are going to want to see if you’ve got a real, in-depth plan for any negative issues that could impact sales.

Remember that it is acceptable (and realistic) to have a negative cash flow projection for the early months of your cash flow projection period.

Good Decisions Depend on Good Information

Instead of estimating one sales figure for the whole year when sales forecasting, a more realistic monthly schedule of income and expenses gives you far more information on which to base decisions. As your business gets off the ground, keeping the books will give you additional information to refine your future sales forecasts.

It’s important to prepare three cash flow projections, where you vary the percentage of sales or other figures to arrive at three different scenarios: pessimistic, optimistic, and realistic. The pessimistic view should be the worst-case situation and needs to illustrate your plan to have enough capital and patience to get through that scenario. If it turns out that the actual results are better than that, you’re in great shape!