Sales forecasting is key to managing your cash flow forecasts accurately, but it can be difficult for new businesses because they don't have any anchors to rely on, such as past sales figures. Alan Gleeson provides the answers in his beginner's guide to sales forecasting
Why do so many start ups struggle with sales forecasting?
Most lack experience in understanding the importance of cash as distinct from profits. Not being able to look at historic sales and to base predictions on these can make forecasting seem impossible. If your product or service is innovative or a hybrid of different products/ services, it's even harder to make an accurate assessment as to likely demand.
There are methods you can use to give you a fairly accurate idea of likely sales in Year 1. Trying to predict beyond that time frame is particularly difficult, unless you are a pretty straightforward business where data is plentiful and where you can use proxies (data from others) to assess likely demand. For example, a local flower shop, butcher or retail shop will have a relatively predictable cash flow, compared to more complex business models.
Why is forecasting important?
Cash is the lifeblood of all businesses - it provides working capital which can be put to productive use. For most businesses costs are incurred up front, following which there's a time lag as you wait for cash to flow in from your customers. There will be uncertainty over the level of sales you'll achieve, as well as when you’ll actually get paid.
Consequently, businesses need to prepare forecasts so they can anticipate when cash is likely to run short. Start ups can then arrange an overdraft extension, loan or other finance to tide them over.
It is perfectly normal for start ups or even mature businesses to need financial support with cash flow, due to delayed payments, uncertain demands or investments in assets with longer term pay-offs.
Does forecasting get easier?
Once you have one month of trading history, you can use that information to forecast subsequent monthly sales. Then in subsequent months you can compare the forecasted figures with the actuals to continually improve your accuracy.
Predicting sales becomes easier once you have 12 months of trading behind you, but all start ups operate in relatively uncertain environments, so optimal timeframes are a year at most. Most businesses also face fluctuations in demand during the year, and these should be mapped (particularly for businesses with inherent seasonality).
How can I estimate demand?
It can be tough, but you need a thorough knowledge of your market - its size, consumer spending habits, your product's market position, the level of competition, your prices and external factors such as the state of the wider economy. These are all crucial factors which can impact demand.
However, there's no better way to gauge demand than speaking to potential customers. And it's not about finding out whether they like your products, it's about whether they will pay your prices and buy in sufficient volumes.
Tell me more about forecasting...
Well, once you've worked out your costs and prices, you have two options: you can base your forecasts on facts if you have them, or subjective assessment if you don't.
The more sales you make, the more you'll be able to base your projections on facts, but in the meantime you'll have to settle for well-informed assumptions based on knowledge of your market. This will give you a good idea of likely demand, although the reality could be greater or smaller.
Can I learn from other businesses?
Sales information about other businesses in your market, if you can access it, can be highly beneficial. Many will not want to reveal such information. For some types of high street businesses, simply going and observing the number of shoppers entering a competitor's' premises can be useful as a proxy. Take a coffee shop as an example - sitting in and observing for a few hours at different times can help you gauge cash flow. Of course most businesses do not afford the same level of visibility.
The cost side of any business is much easier to forecast, as many of the core costs are knowable.
Should I be optimistic or pessimistic with my forecasts?
It is much better to err on the side of prudence - over estimating costs and under estimating revenues. I'd recommend accuracy, if not caution, so you won't be faced with any unpleasant surprises. If you base your business on over-inflated sales forecasts and revenue falls short, you're in for trouble. The whole point of sales forecasting is to produce realistic estimates, not to get carried away.