3 Sales Forecasting Methods

Sales Forecasting by More Than One Method Is Most Accurate

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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. Here, Terry Elliott provides a detailed explanation of how to do forecasting using three common sales forecasting methods. 

Note that there are all sorts of 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 do multiple estimates so you (and they) will have more confidence in the forecast.


How to Forecast Sales

Method #1

For your type of business, what is the average sales volume per square foot for similar stores in similar locations and similar size? This isn't the final answer for adequate sales forecasting, since a new business won't hit that target for perhaps a year. But this approach is far more scientific than a general two percent figure based on 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 competitors? Do the same for within five miles (with lower sales forecast figures). (Use distances that make sense for your location.) For example:

Acme Corp Sales Forecast
Distance#HouseholdsAnnual Spending% of SpendingForecast Sales
1 Mile20$5,0005% ($250)$5,000
5 Miles500$5,0002% ($100)$50,000

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) to your six month sales level. For example: 

Bubbles Corp Sales Forecast - Month 1
ItemUnit PriceMonthly SalesMonthly Revenue
Hot Tub 1$15005$7,500
Hot Tub 2$25002$5,000
Hot Tub 3$30002$6,000
Bubbles Corp Sales Forecast - Month 2
ItemUnit PriceMonthly SalesMonthly Revenue
Hot Tub 1$15008$12,000
Hot Tub 2$25004$10,000
Hot Tub 3$30004$12,000
Bubbles Corp Sales Forecast - Month 3
ItemUnit PriceMonthly SalesMonthly Revenue
Hot Tub 1$150010$15,000
Hot Tub 2$25005$12,500
Hot Tub 3$30005$15,000
Bubbles Corp Sales Forecast - Month 4
ItemUnit PriceMonthly SalesMonthly Revenue
Hot Tub 1$150013$19,500
Hot Tub 2$25007$17,500
Hot Tub 3$30007$21,000
Bubbles Corp Sales Forecast - Month 5
ItemUnit PriceMonthly SalesMonthly Revenue
Hot Tub 1$150018$27,000
Hot Tub 2$25008$20,000
Hot Tub 3$30008$24,000
Bubbles Corp Sales Forecast - Month 6
ItemUnit PriceMonthly SalesMonthly Revenue
Hot Tub 1$150020$30,000
Hot Tub 2$250010$25,000
Hot Tub 3$300010$30,000

Now carry it 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. Then put the figures in by month, as depending on your business, there could be huge variations by month. (Some retail firms do 50 percent of their gross sales around Christmas, from the end of October to the end of December, for instance, yet barely get by June through August.)

Estimate Costs/Expenses

A sales forecast should also include direct costs so profits can be estimated, for example:

Bubbles Corp Expenses - Month 1
ItemUnit CostShippingMonthly SalesMonthly Cost
Hot Tub 1$500$1005$3,000
Hot Tub 2$1000$1002$2,200
Hot Tub 3$1200$1002$2,600
Service Cost$80 10$800
Installation Cost$200 5$1,000
   Total Direct Cost$9,600

Direct costs vary by business/industry:

  • For a reseller of goods the direct cost of each item sold (also known as 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 credit card expenses for items sold by credit card can also be included.

Taking a Sales Forecast to the Bank

If you're going to a bank for financing, be able 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 what happens if your competition cuts the price by 33 percent and still makes a profit?
  • How will you grow your business specifically - 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? Any potential lenders are going to want to see if you've got a real plan.

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

You can see that instead of estimating one big sales figure for the year when sales forecasting, a more realistic monthly schedule of income and expenses gives you far far more information on which to base decisions. That's what "keeping the books" is designed to do: give you information you can make good decisions on.

So in effect, you need 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; plan to have enough capital and patience to get through that scenario. If it turns out that the actual results are better than that - great!

Accounting Software Can Help

Accounting software can be a great help in creating sales forecasts, cash flow projections, and keeping track of your expenses. See 6 Advantages of Using Small Business Accounting Software and The Best Accounting Software for Small Business.

See also:

Preparing Cash Flow Projections

Cash Flow Management Tips to Keep Your Cash Flow Flowing

How to Conduct a Breakeven Analysis

10 Low-Cost Ways to Promote Your Business