If there is one crucial piece of financial management you must do at whatever stage you are in your business – you must prepare and regularly update a cash flow forecast for at least the next 9-12 months. And the most important line in the cash flow is the sales assumptions – being up or down on sales will have a direct and possibly major impact on cash.
Given the uncertainty around sales forecasting it is tempting to say why bother. I can understand this feeling. However you will find the process of undertaking a sales forecasting exercise incredibly useful and later I will discuss some techniques to help you.
If you are starting up then all the clichés around “taking twice as long and costing twice as much” are sadly true. Getting customers and making sales is the toughest and actually most expensive activity the business does. You need to understand your sales cycle – how many contacts does a customer need before they buy (at least 4 usually) or how many visitors do you need to the website to make one sale.
If you are starting up, you may not have any historical information to extrapolate from there are people with experience who can offer you realistic guidance on your assumptions. And documenting your assumptions or metrics as they are called will help you set your marketing/selling priorities. This will give you targets, month by month to aim for. This will also act as an early warning in case your business model isn’t working.
And if you are already well established you still need to forecast to minimise the danger of over trading. Over-trading is when you expand too rapidly and run out of working capital (because money is tied up with customers and in stock less what you your suppliers). This is exactly what happened to children’s rainwear business Baggers – they launched, and grew the business to £1m+ sales but without enough working capital to fund this expansion
Here are my Top tips to help you with your sales forecasting.
- Break your forecast into blocks. The first block is distribution channels – this is how you reach your customers. For example a skin care company might do online sales and via the high street, so you would separately forecast online sales and high street.
- Then for each channel forecast each main product category and do this using quantity x price. By analyzing each element you are building confidence (and investor confidence because they can follow your story).
- The focus initially is very much looking at the quantities and what drives the quantities. For an online freemium business model you would need to make an assumption about what % of visitors take the free offer and what % then go on to the paid service (usually quite low!) and don’t forget churn – the lifespan of your customers.
- As part of your sales forecast do bear in mind seasonality eg August holidays and crucially the rate of build up of sales.
- It is a common mistake to underestimate how long it takes to build up sales, especially when you are an unknown brand. The biggest strength of the US economy is its customers who are willing to give new products a go. In Europe a new customer typically takes 4 contacts before buying (maybe less on the internet) but its still a big cost/resource that you mustn’t underestimate. This is why investors pay such a lot of attention to the marketing section of your business plan which sets out how you are going to build that bridge to your customers.
- Finally always do a sensitivity a “what if” – what if sales are up 10%, what if they are down 10% – what is the impact going to be.
So having constructed your first draft forecast what’s next? Well you need to “realism” test it. You can do this by networking with people in your industry, finding out about the growth rates of their companies. I have found people are very happy to talk about their business – especially with a bit of flattery. But what if your product is really a first, well you can look at growth rates of companies selling to similar customers at similar price points eg in fashion how long did it take LK Bennett to get their 10th shop?
It’s all about realism and reasonableness – this is the objective for your sales forecast – to be reasonable. And whatever you do, if you are approaching investors, never ever describe your forecast as conservative. They have just seen too many “conservative” forecasts missed by a mile…you are aimimg for realistic.