FORECASTING

Definition:

Sales Forecasting is the process of estimating what your business’s sales are going to be in
the future.

Sales forecasting is an integral part of business management. Without a solid idea of what your
future sales are going to be, you can’t manage your inventory or your cash flow or plan for
growth. The purpose of sales forecasting is to provide information that you can use to make
intelligent business decisions.

Sales forecasting for an established business is easier than sales forecasting for a new
business the established business already has a sales forecast baseline of past sales. A
business’s sales revenues from the same month in a previous year, combined with knowledge
of general economic and industry trends, work well for predicting a business’s sales in a
particular future month.

Sales forecasting for a new business is more problematical as there is no baseline of past sales.
The process of preparing a sales forecast for a new business involves researching your target
market, your trading area and your competition and analyzing your research to guesstimate
your future sales. See Three Methods of Sales Forecasting for an explanation of how to do this.

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 sales forecasting.

“One point to remember when sales forecasting is that if you plan to work with a bank for
financing, you will want to do multiple estimates so as to have more confidence in the sales
forecast.”
Reasons For Undertaking Sales Forecasts

Business are forced to look well ahead in order to plan their investments launch new product
decide when to close or withdraw product and so on. The sales forecasting proses is critical one
of most business. Key decisions that are derived from sales forescast include:

• employment level required

• promotional mix

• invesment in production capacity

There are all sorts of ways to estimate sales revenues for the purposes of sales forecasting:

• Sales Forecasting 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 2 percent figure based on household
incomes.

• Sales Forecasting 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. Example : Use distances that make sense for your
location.

• Sales Forecasting Method 3

If you offer say, 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. Now carry it out from months six through 12 for a complete
annual sales forecast.

Additional of Sales Forecasting Methods

Sales Forecasting Using Qualitative Methods

These methods rely essentially on the qualitative judgment and information of highly
experienced practitioners or experts in a specific area, and translate their opinions into
quantitative estimates of the revenue model of a specific business, product or service.

Jury of Executive Opinion Method: Very popular in practice, this method calls for a group of
experienced executives and experts to get together in a structured discussion forum, and in
which a moderator would work towards pooling the contrasting views of these executives on
expected future sales and demand and combines them into a revenue and demand estimate
that they can all agree on.

Delphi Method: The Delphi method also relies on the views of a pool of experts, but they do not
interact face to face, and the demand forecast and revenue model is constructed through an
iterative process. The advantage of this method is that it avoids group-think, which may
sometimes creep into the Jury of Executive Opinion method, when the pool of executives start
agreeing with one another without through independent and objective thinking.

Sales Forecasting Using Time Series Projection Methods

Demand projection methods based on time series generate sales and revenue forecasts on the
basis of historical data and trends.

The important time series projection methods include:

Trend Projection Method: The trend project method involves the direct extrapolating historical
sales and revenue trends in the future, primarily those of growth and customer conversion rates.
This method works well for stable businesses that have not experienced significant change in
their financial profile in the past years, and expect to continue on a similar track going forward.

Exponential Smoothing Method: In exponential smoothing, sales and revenue forecasts are
modified by examining potential bumps or errors in observed historical demand data trends, to
ensure that historical demand rates that are exceptionally high or exceptionally low due to a
one-off event are not carried into future revenue projections. This method is useful for
discounting the impact of exceptional events such as a sudden spike in sales due to an
unsustainable trend on the historical sales performance of a business.

Moving Average Method: In the moving average method, a simple arithmetic average or a
weighted arithmetic average of a reasonable historical sales data window are used to forecast
future demand. This method works well for businesses which periodically experience
adjustments in their revenue profile or structure, but bounce back to similar historical levels after
a certain time period.

Sales Forecasting Using Casual Methods

Even more analytical then either of the qualitative or quantitative methods alone, casual
methods take a statistical correlation approach to develop sales and demand forecasts on the
basis of cause-effect relationships in an explicit, quantitative manner.

Some of the more important casual methods used in financial modeling and forecasting include:

Chain Ratio Method: This method applies a series of factors for developing sales and demand
forecasts, in which the quantitative impact of each factor is layered upon another in a structured,
analytical approach.

Consumption Level Method: Useful for a product that is directly sold and consumed, as such
fast moving consumer goods or telecom services, this method estimates demand / consumption
levels on the basis of elasticity coefficients, such as the income elasticity of demand and the
price elasticity of demand.
End Use Method: The end use method develops sales and demand forecasts on the basis of
consumption coefficients of the product or service for various uses, and is most suitable for
intermediate products / services.

Leading Indicator Method: Observed changes in the leading demand indicators for a product
or service are used to predict the changes in lagging demand variables, most suited for
products / services with predictable or seasonal demand cycles that are predicated on the
occurrence of certain related events or customer behavior.

Insurance

The insurance industry is based on effective risk analysis. While the basic premise is quite
straightforward an insurance company accepts the risk of a loss in exchange for a premium the
business realities are not.

Risk-based Visibility

Insurance companies require complete risk-based visibility into their business. At the enterprise
level, you need to analyze your policy portfolio as a whole to ensure company solvency with a
high level of confidence. For greater detail and understanding, you must also drill into their
portfolio to analyze the performance of particular policy types, customer groups, geographies,
etc. Using sophisticated risk analysis methods, you need to identify your most important risks
and opportunities to know where to focus your attention and how to make the best decisions.

Solutions

The Vanguard System is a comprehensive business solution for improving the quality, reliability,
and speed of management decisions. It does this by helping you Collaborate with colleagues on
important plans, Analyze alternatives using state-of-the-art modeling and simulation techniques,
Automate routine decisions using expert system technology, and Improve overall management
effectiveness by adding structure to a normally chaotic process.

Business improvement is all about working smarter. Vanguard brings together the people,
analytics, and systems required to help your business operate intelligently.

Here are just a few of the ways Vanguard supports the insurance industry:
 • Risk analysis: Fully quantify your risks at any business level, from the corporate
enterprise down to individual components of your policy portfolio, using sophisticated
modeling and simulation techniques.

• Forecasting: Predict claim frequencies and payout amounts with our comprehensive
forecasting analytics.

• Mix / Portfolio analysis: Optimize policy portfolios, premium pricings, and promotions.

• Operational efficiency: Conduct process improvement/Six Sigma projects to reduce

costs, cycle times, and waste.

• Knowledge automation: Expertly guide employees through complex processes, such

as claims reviews or compliance audits, using intuitive question and answer sessions.
Reduce administration costs while improving reliability.

Forecasting Summary

• I guess 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 more information on which to base decisions. That's what "keeping the books" is
designed to do give you information than you can make good decisions on.

• So in effect, you 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.

• Sales are the lifeblood of any company, and getting a reasonable estimate of sales
revenue scale and growth is highly critical in any ensuring business planning exercise,
such as capital investment decisions, hiring of staff, expansion of business operations
and allocation of operating budgets, etc.

• Hence, forecasting demand for a company’s products and services, and the resulting
revenues accrued is probably the most critical step a financial analyst needs to
undertake when building a financial model.
• In order to arrive at a realistic and reasonable revenue forecast for a business, a good
financial analyst should conduct a detailed revenue modeling / demand analysis of a
company’s products and services, by examining its usage potential and a customer’s
willingness and ability to pay.

• A demand analysis would entail determining current demand and using assumptions
for demand build up to predict future demand over the time period of the financial
model. There are a number of qualitative and quantitative methods that can be used to
conduct a demand analysis.