Financial forecasting is a significant part of financial planning process. The financial forecasting begins with sales forecasting. Sales forecast is a forecast of firm’s future sales both in terms of volume and value. The sales forecast always begins with analyzing the historical trends in sales over the past periods. It also takes to consideration the future economic prosperity if given line of business. To determine the forecasted sales growth, the firm must rely on competitive market conditions, customers tastes and preferences, change in technology and future possibilities of market expansion. Nowadays, several statistical methods like regression analysis, time series analysis, econometric models are used to consider all these factors in providing sales forecasts.
Some factors that should be considered while developing sales forecast are as follows:
- Provide a projection of divisional sales based on historical growth and combine the divisional sales forecasts to provide a approximate corporate sales forecast.
- Forecast the level of economic activity in each market area of the firm along with the change in population and their economic growth.
- Estimate the market share of the firm that is expected in each market area depending on the firm’s production and distribution capacity, capacity of competitors, possibility of new product and so on.
- Forecast the effect of future rate of inflation in the consumer’s purchasing power and price of products.
- Consider the effect of advertisement campaigns, price discounts, credit terms and so on.
- Provide the ultimate forecasts of sales for each division in aggregate and on an individual product basis.
The sales forecast must be as accurate as possible. If it is overly optimistic, the firm may have idle plant capacity and unnecessary investment in inventories. If the sales forecast is overly pessimistic, it may result into loosing the customers because of failure to meet demand. Both of these conditions result into low profit margin, low return on assets, low return on equity and decline in market price of share. Therefore, accurate sales forecast is significant to improve profitability of the firm.
Sales Forecasting Methods
There are several methods of sales forecasts. Some of them are as follows:
- Sales persons – A firm can employ its sales persons to provide a close forecast of sales. These sales person are employed at many places where firm’s products are offered. They collect market information personally from customers, collect customer’s response to the firm’s product and thus provide an estimate if likely sales that the firm can achieve in the future.
- Customer Survey – It is a formal process of sales forecasts applied by the firm on the basis of survey of customers in many places. Firm employs some survey people to visit many customers of many places and takes the response of existing as well as prospective customers on the basis of direct interview and questionnaire. Existing and prospective customers are asked to give their opinion verbally or in written format about the product offered by the firm. On the basis of opinion survey of customers, these survey people provide an estimate of future sales.
- Time Series Model – Time series model is a mathematical model of sales forecasts. This model assumes that level of sales varies according to change in time period. A time series model states that the relationship between two variables, one of them being the time period and another being sales. A series of time period is regarded as independent variable and the level of sales over several time periods is used as dependent variable. Under this method, past sales data are arranged chronologically and statistical analysis of these chronological sales data is made to forecast the level of sales in some future date. Here the sales level is regarded as a function of time period. The time series model is stated as Yt = f(t), where, ‘Yt’ represents the value of sales in time ‘t’.
- Econometric Model – Econometric model is an important model used in sales forecasting. This method assumes that sales of firm are influenced by many factors such as level of inventory, advertisement expenses, cost of production, cost of quality control, research and development expenditure and so on. Sales are regarded as dependent variable and all other factors under considerations are regarded as independent variables. Once these variables are identified, they are into the following model to provide a forecast of sales. Y = a+b1X1+b2X2+b3X3+………..+bnXn+e, where, Y = Estimated sales, X1,X2,X3 = value of independent variables influencing sales, b1,b2,b3 = the coefficient of respective independent variables, a = the intercept constants and e = standard random error term.