One of the crucial elements of a new startup’s success is budgeting and financial management. In fact, 16% of businesses go out of business within the first year of operation due to financial problems. It doesn’t cost a lot to validate your idea in the early stages but as soon as you start to grow your business, you will need to get your budget under control.
Want to know how you prepare a budget that holds water? With sales forecasting, you can determine an estimate of the required revenue forecast of your company, production, cash flow requirements, and more.
Now, let's dig into how you can forecast sales for your startup business!
When You're Done Reading, You'll Know
- How to optimize your critical decision making with sales forecasting
- Why the dynamics of forecasting is important
- Whether you should choose a top-down or bottom-up strategy in your startup
- Which opportunities you can derive from efficient sales forecasting
What is Sales Forecasting, and Why is it Important?
The first thing you need to keep in mind is the definition of sales forecasting. Sales forecasting is a form of budgeting that involves predicting the number of products you will sell within a defined period.
The prediction is usually based on historical data, but you can also use data from competitors and general economic trends. Sales forecasting is crucial to your financial health and business operations because it guides the required production level and the related costs. On a personal level, you might be all right with buying a new pair of boots every month. But if you’re going to sell boots, you don’t want to be stuck with 50 pairs you can’t sell. That’s why you forecast.
Let’s dive a little bit deeper and have a look at a forecasting example. Suppose you forecast an increase in sales volume of 25% in the next three months. This information can help you make critical business decisions: How much should you produce? Do you need more staff? Or less? How should you handle and distribute your resources to achieve the exact predictions? Forecasting is all about predicting the future as best as you can to make sure you even out your resources and reach your goals. If you were to run a marathon, you wouldn’t spend all your energy on the first 5 miles, would you?
Just as you can forecast growth, you can also forecast decreases in sales volume in the future. This can help you take preventative measures such as scaling back production on specific products or services.
So, What are the Pros and Cons of Sales Forecasting?
Sales forecasting can be a useful tool for your business if you implement it correctly. However, it does have its limitations. Before you decide to make a sales forecast, you need to understand the advantages and disadvantages it can provide.
The best thing about sales forecasting is that it can align your business strategy with actual results. The insights you get from forecasts make it possible for you to act in time and in the right way. This means that even before you see actual change in the market, you can distribute your products and resources to match those changes. Essentially, a sales forecast is like a fortune teller that gives you a sneak peek into your business’ potential future.
For example, if you forecast a 20 per cent increase in sales volume over the next quarter, you can mobilize everyone to put in an extra effort.
Adjust it for Popular Demand
Another advantage of sales forecasts is that they are adjustable. You can use the data you collect from, for example, marketing activities to modify your forecasts. If you see a high engagement on one product and a particularly low engagement on others, that may help indicate what your customers like most as well as the changes over time.
For example, if you see a higher engagement or increased demand for one product in Q4, you can increase its production during that quarter to maximize profits.
And the same goes for low engagement. If you find that one product isn’t as popular as you thought it would be, you can quickly scale down its production rather than wait for the end of the quarter to receive sales figures.
Sales forecasting allows your business to be more flexible and make adjustments like a professional acrobat, always tweaking operations to match changes in the market. Just like you wait to pick the apples from an apple tree until they are ripe and juicy, forecasts put you in a better position to take advantage of the opportunities at exactly the right time.
There are some drawbacks to sales forecasting too. That doesn’t mean that you should avoid doing them - it’s just better to come prepared, right?
There is No ‘I’ in Team
The forecasting process is time-consuming and requires that you put multiple skills into use as an entrepreneur. If numbers aren’t your strong suit, you might need to reach out and get some assistance. Doing forecasts may push you to delay other activities because it takes time to do it alone or get outside help. Depending on these factors, you may have to consider how you can make the forecasting process smoother and more feasible for your business.
Is There Such a Thing as Too Optimistic?
Another thing you should remember is that sales forecasting comes with a degree of uncertainty, and it can be easy to forecast results that are more positive than realistic. This can build biases or optimism on the team, which can lead to inaccurate results. For most founders, their startup business is a dream come true, and we can sometimes be blinded by how much we want it. But making the dream succeed requires you to take on a different pair of glasses and see your business in a more critical light. If you can’t seem to pull yourself out from the honeymoon phase, hire someone who isn’t afraid to tell it how it is. It’ll be worth it in the end.
Remember, forecasts cannot factor in everything. For example, a global pandemic can deem the sales forecasts for that period outdated and irrelevant, something which many businesses have experienced in genuine ways the past year. This is why you should have a flexible approach when making your forecasts, so if and when the wind does change, you are ready to sail in a new direction.
How to Approach your Sales Forecasting?
For startups, it can be challenging to carry out an effective sales forecast, because you don’t yet have that much data to go from. So how do we do it?
Top-Down or Bottom-Up?
Early-stage businesses often go for a top-down approach to forecasting, meaning that instead of using their own data, they study the market on a macro level. Looking at the market from an eagle's perspective can help you see and decide where and when to strike your target.
Going with this method of forecasting is a good place to start. Just remember that there are a lot of factors you won’t be able to consider this way. By doing a top-down forecast, you will have good indicators, but the uncertainties we mentioned earlier are much bigger. In practice, this means that you probably won’t hit the targets you set, but if you come close, you’ve done a good job.
An alternative to this method is taking a bottom-up approach that not only considers the market’s macro factors but also your own business' expected performance. The bottom-up forecast is based on your company’s capabilities to produce and deliver your solution to customers and also considers the initial demand for the solution.
The advantage this has over a top-down approach is that your forecast will be based on actual financial figures, and not just an assumption of what you perceive from the market analysis.
Set the Date
When you are making a sales forecast, you need to determine the time frame for your projections. A good period for a detailed sales forecast is one year. This covers four quarters and by the end of the period, you should have accurate and useful data to put into play for your next forecasting endeavors.
If you are going after long-term projections, we recommend that you aim for three to five years. Remember, sales forecasts become less potent as you increase the time span. Do you know where you will be in ten years? Probably not. Set your goals, but keep in mind that things will change along the way. They always do.
The Sales Forecasting Process
To forecast your sales effectively, the first thing you need to do is categorize your products into sales lines. How you choose to group products depends on the type of business you are running.
For example, a business to business software-as-a-service (B2B SaaS) company might choose to organize their products by the number of employees, while a restaurant might choose to organize them by the time of day.
By setting up sales lines and grouping your products in different characteristics, you will make the forecasting process more efficient. By doing this you can avoid making individual forecasts for each of your products and thus reduces the hours spent.
In a mobile phone store, for example, you can choose to do forecasts based on all the different types of phones you have available. By categorizing products and services into new phones, refurbished phones, accessories and customer service, it will be much easier to collect useful data that you can use in future forecasts.
After you’ve determined your sales lines, you need to choose a method of sales forecasting.
The primary sales forecasting method is to multiply the total number of units you plan to produce for a sales line with the unit price. This will calculate the total sales revenue.
Another way is to determine the total number of units needed to achieve a particular sales figure.
You can choose to view your sales forecast by month or by quarter. Just remember that forecasts are dynamic. When your startup changes, they change, so you should go through your sales forecasts periodically and incorporate new data to constantly keep them up to date.
Factors to Consider for Your Sales Forecasting
Both internal and external factors can influence your sales forecast. For example, your competitor's performance will directly impact your sales volume, so you need to adjust your forecast to accommodate it. Here are some of the factors that would be beneficial to consider when forecasting:
If a competitor is doing well, you may need to employ tactics, like discounting, to level up your own presence. Alternatively, if a competitor goes out of business, you can seize that opportunity to capture some of their market shares and increase your own.
Macroeconomic factors, meaning everything from regional to global changes will have an effect on your sales. It’s easier to sell most goods in a strong economic climate and harder if the general economy is bad.
Events that affect the national or global economy negatively overall can sometimes have a positive impact on some businesses like we’ve seen in the recent pandemic, which has caused many businesses to struggle, but at the same time have massively benefited the producers of hand sanitizer and face masks.
Changes to regulations or legal requirements can also impact your sales if your product or your business structure is affected by it.
The time of year can also impact your sales. For example, an ice cream shop will have very good projections for the summer, but very slim projections for the winter, while toy stores project big spikes in the months around Christmas, compared to other times of the year.
Your sales forecasts are also affected by internal factors, such as your employees. For example, it’s very common to see tech startups hire an army of salespeople as soon as they get the funding for it because the number of people working to sell a new product directly impacts how much is being sold.
If you are starting a new business, you need to factor in the time required to set up sales pipelines and establish relationships with other stakeholders.
Your company's policies can also impact your sales forecasts by potentially limiting the available options for sales teams.
Methods of Sales Forecasting
There are multiple sales forecasting methods to choose from. The most basic type of forecasting is based on historical sales data.
View Your Historical Sales Data
The way to do this is to compare the period you want to forecast with a corresponding earlier period. For example, if you want to predict the sales volume of Q4 in 2020, you can look at the historical sales data of Q4 in 2019 and determine a reasonable estimate. If your forecasts are affected by time specific factors, this method makes a lot of sense.
The problem with using historical data to predict the future is that clinging to the past can sometimes put blinders on you. In other words, the method assumes that the demand for products will remain the same year-over-year and doesn’t initially consider external factors that can otherwise affect your sales. In that sense, this method doesn’t always work well as a decision-making tool, because it may prevent you from seeing new options.
For example, 2019’s data has been pretty useless for most businesses to predict 2020, because 2020 has been massively affected by an external factor that wasn’t present in 2019. However, using this forecasting method (in non-pandemic times) gives you a benchmark to measure and compare your current performance with.
Forecasting for Opportunities
Another method of sales forecasting is to forecast opportunities. This method categorizes sales based on the likelihood of their success.
For example, a typical sales process includes initial contact, response, negotiations, and completed sales. This method uses the probability of closing a sale and that sale’s potential value to make the forecast.
In the opportunity forecasting method, you can decide based on the likelihood of sales completion and identify the stage where your sales process does not perform up to the standard.
Looking at this method from a real-world perspective, you would analyze at which stage the sale of a product fails. For example, if you find out that you lose most sales at the negotiation stage, you would probably want to have a look at your strategy or skills in that area and make improvements from there.
This method has some drawbacks, such as its reliance on historical data and its failure to consider the total time of a sale.
Sales Cycle Forecasting
The sales cycle forecasting method is based on the time it takes to close a sale. The time it takes for you to initiate contact until a sale is final is most likely similar, if the product and customer are similar to each other too.
In other words, this method forecasts how long a specific sales cycle is (and thus how many products you can sell in a specific period) by looking at the length of your average sales cycle. The forecasting method is based on objective data, but it doesn’t account for the natural differences of each individual sale.
The Multivariate Analysis
If you’re up for the task, this method will give you the most accurate and usable sales forecasts and is by far the most reliable crystal ball you can get your hands on.
This method of forecasting integrates multiple factors that influence sales volume. These factors include things like individual rep performance, average sales cycle length, and the probability of closing based on opportunity type.
If you want to use multivariate analysis for forecasting, software for carrying out complex analyses is the way to go. And you need to up your data game too. Make sure your data set is reliable and frequently updated, otherwise your results will be messy and inaccurate.
How to Create a Sales Forecast
Now that you know pretty much all you need about sales forecasting, you’re ready to make your own. While there are probably some geniuses out there who get a kick out of doing this by hand, if you’re a regularly gifted person, we recommend you start looking for software to help you out. What you need is software that can handle large data sets and produce readable charts and graphs.
Most people use spreadsheets, for example, Microsoft Excel to make forecasts. Spreadsheets can be great, especially for basic level forecasting, but as soon as you start working with bigger data sets, you run the risk of suffering a horrible death by spreadsheet. Especially if you’re not a number person by nature. Luckily, there is software out there that makes it simpler and faster to do your forecasts. For example, the Cuttles app has a budgeting feature that helps you produce sales forecasts by simply adding your numbers. You don’t have to know or use any formulas. Our platform provides you with a streamlined interface that presents information in an easily digestible way, and you can understand your forecast even if you have limited financial knowledge.
All you have to do is enter your data such as your projected revenue, growth rate, and currency. Our app will then create your forecast and set up good looking graphs and charts to give you a clear overview. If you add your expenses and capital too, you have a full budget for your startup, which will help you make decisions throughout the early stages of your venture. Our backend is constantly crunching your numbers and gives you tips and advice on how to optimize your budget. Pretty neat, huh?
With the right tool to handle your forecasting, presenting your startup to investors and stakeholders and making business decisions gets a lot easier. Working with numbers won’t be boring or scary. Instead, it will almost feel like you’re predicting the future. And who doesn’t want that for a job?
Our Final Thoughts…
- The year 2020 and 2021 has shown us how unpredictable the business world can be. External forces bring a high level of uncertainty to your business and can significantly impact your business.
- To navigate this, you need to develop methods and models that will provide concrete metrics for measuring your business performance and predicting what needs to happen next. The lifeblood of any business is its revenue stream, and sales forecasting is the key element of predicting future revenues.
- Choosing the right forecasting models is essential because inaccurate projections can lead to big problems for your startup business. Doing ineffective or inaccurate forecasts is a waste of your resources and won’t help you in the long run.
- For startups or small businesses looking to expand, accurate sales forecasts are a must-have in determining future expected growth.
- Forecasting is not just a tool for you to seize market opportunities. Financial projections are vital to investors too. You will have a greater chance of securing additional funding from investors, by presenting convincing numbers to them now and in the future.
- While number-loving founders might still enjoy the thrill of building up spreadsheets, there is software out there that makes it much easier while still providing you with powerful forecasts.
By using Cuttles, your sales forecasting numbers are just a click away, making them even more accessible to both you and investors than before.
Good luck - and happy forecasting!