Sales forecasting methods and their flaws
The first thing you need to know about sales forecasts is that they’re never going to be right – not 100% anyway. The idea is to make the margin of error as small as possible.
There are dozens of sales forecasting methods, but most of them are built for existing businesses. They require you to have information about past sales. New businesses don’t have that luxury. That leaves you with four options – and you should probably use at least two of them.
1. The ballpark method
Start by identifying the total target market and work your way backwards to see how many could become customers. Do this exercise for your first three months, your first six months, and your first year. Check your assumptions with an industry insider or an accountant.
How many of the target market can you connect with? And what portion of them will switch to you?
Categorise your most likely customers by age, profession, location and so on. How many people fit the description of your target market? Your marketing will only reach some of that group. And you can only expect to win a portion of those as customers. Whittle the numbers down as realistically as you can.
2. The borrowed-homework method
No matter how wonderful or weird your business is, someone’s doing something like it, somewhere. Their business doesn’t have to be identical to yours, just similar. Find those people and ask them how sales have gone.
You don’t need to pry into their finances, or get exact numbers. Start with broad questions about their business. A lot of owners will open up and share their story.
Don’t compare yourself to outliers. If another business went viral for some reason, they’re not a good model for your sales forecasts. Virality is not, unfortunately, a strategy.
You can get a lot of useful information by asking simple, unassuming questions.
3. The working-backwards method (setting a sales target)
You could start the forecasting process by seeing how many sales you need to sustain a viable business. This isn’t a sales forecast so much as a (minimum) sales figure.
Once you know the minimum your budget will allow, some market research can help you see if that’s a realistic sales target. You could start by asking other businesses that serve the same market. Or you could go direct to customers and ask about their buying habits.
If it seems feasible to hit the target, you might make (or buy) the corresponding amount of product and set out to sell it. This method is more likely to be used by someone who’s turning a hobby into a business. It allows them to start small, build slowly, and control costs.
Instead of a sales forecast, some new businesses use their budget to set a minimum sales target.
4. The ask-an-expert method
You know who’s seen a lot of business ideas, budgets and forecasts? Accountants and bookkeepers. Investors, too. Go and speak to them. They love to hear about new business ideas.
Some advisors will give you the first chat for free. But even if they charge you, you’ll gain a lot of useful information in one short visit, so you’ll get great value. Use one of the sales forecasting methods above to generate your own set of rough numbers and ask them for a sanity check.
Find an accountant or bookkeeper who has clients in your industry. It sometimes helps if they’re local too – though that’s not always vital.
You can search advisors by industry and location in the Xero advisor directory.
Do your own numbers before visiting an advisor. It gives them something to react to.
Do several sales forecasts when starting a business
You don’t know how well your new business will go, so explore a few options. Run a scenario with really soft sales, one with strong results, and another in the middle.
That’s how to start a business with confidence, because you’ll be prepared for all eventualities. If sales start slow, you’ll have a draft budget for that. If business booms, you’ve already done some thinking about how to meet the demand. Working through the scenarios will teach you a lot. Have fun with them.
Chapter 7: Pricing and cost of goods sold
If you want to make money in business, you need to know your COGS (cost of goods sold) and you need a good pricing strategy. We take you through both.Read chapter 7