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Most entrepreneurs struggle with putting their financial projections together. It is difficult to forecast what the market’s reaction will be to your idea, and most entrepreneurs do not want commit to sales projections that they cannot meet. On top of this, they do not know what investors and lenders are looking for in these projections.
Calculating your estimated sales is probably the most difficult number to compute when preparing your business plan and evaluating whether your new business will be feasible. Luckily, you don’t need an accounting degree to put together a sales forecast. There are numerous variables and assumptions involved in any sales forecast: location, competition, experience, market contacts, and pricing strategies. In the end, it is nothing more than an educated guess.
According to research from the Aberdeen Group, companies with the ability to accurately forecast sales are 10% more likely to grow their business and twice as likely to be market leaders. For the startup business, it is critical to be as accurate as possible in the sales forecast section of your business plan. The sales forecast will likely determine the feasibility of your new business as well as your ability to attract investors and borrow money.
However, estimating sales is not an exact science. Therefore, if you are going to err in preparing your sales forecast, err on the conservative side in predicting your sales. If your sales forecast is overly optimistic and you run short of funds, banks and investors will question the accuracy of your modified sales forecast, making it difficult to secure additional funds.
If you have significant experience in your industry and your market, your sales forecast may be as accurate as you can get. However, if you require investors or bank financing, you will need to put together supporting documentation to justify your sales forecast.
Remember that your sales projection is nothing more than an educated guess. While these sources can provide you with information on the size of the market, your ability to penetrate that market is your sales forecast.
Your sales forecast should cover a minimum of 12 months; some creditors will even require three to five years of projections. The secret with sales forecasting is to categorize the different types of sales you can expect and calculate how many of each per month. The more assumptions you make, the less accurate your forecast will be. Try to drill down into the details and be objective.
The following are tips that may make it easier for you to prepare your sales forecast:
The easiest way to complete a sales forecast is in a spreadsheet. Each column will be the month of the year and the rows will be your different projects or services. The first group of rows should contain your units sold for each product, the second group of rows is the unit price for each group of products, and the third section will be total dollars of sales by product line.
Several business consultants recommend that you add two more groups of rows to your sales projection. The fourth section would be the cost per unit sold to calculate the cost of goods sold and the fifth section would be your gross profit. This will allow you to see how changes in pricing will impact your ability to cover your fixed expenses.
The prices you charge for your products or services can have a dramatic effect on sales and profits. Your pricing strategy also determines how customers view and respond to your product or service. To make sure your strategy is effective, it’s important to consider the different pricing options. Consider these two factors:
An appropriate pricing strategy complements the position of your product or service. For example, a high price will likely suggest a premium value to your customers.
This is an essential starting point to avoid selling at a loss. What you're aiming to do is calculate all the costs in producing your product or service, then add a margin for your profit. It's prudent to have your accountant ensure that you haven't missed anything, including that your price includes enough profit to grow your business.
For example, if you’re selling outdoor furniture, you need to add up all the costs of manufacturing the furniture – raw materials, labor costs etc. – then add your profit margin on top.
What cost-plus pricing doesn't do is consider demand, what the competition is charging, or market expectations.
Let’s say your business manufactures costume jewelry and the cost to you to make a necklace (including raw materials and the time you spend making it) is $25. You also need to factor in an amount for overheads. The best way to do this is to add up all of your overheads and divide that by your estimate of how many sales you expect to make. As an example, if your overhead divided by the expected number units sold is $20 per necklace, then your sales price would need to be $45 just to breakeven Can you sell them for that much?
This is what you’d work on if your business is service-based, such as gardening and lawn mowing. What you need to do here is work out how much you’re going to charge your customers per hour. For example, a lawn-mowing business would need to take into account all of the expenses involved in completing a job: wear and tear on the mower, gas costs for both the mower and travel to the customer’s property, and the cost of their own labor.
Let’s say your base is $5 for fuel and equipment wear and tear, plus another $5 to travel to the customer. You might be charging your labor at $25 per hour. Then you need to add overheads, so if yours are $50,000 annually and you can work 2,000 hours a year, you'd add in $25/hour for overheads. Finally, you need to add profit. If you've decided you want a salary of $100,000, then at 2,000 hours that's $50.
So now the charge-out rate is $50 profit + $25 overheads + $25 labor and petrol.
If $100 is way over the market rate, then you can look at lowering your overheads and variable costs. Or you could work longer hours and reduce your profit margin.
Combining margin retail and hourly-rate pricing is something you’d do if your business offers both a product and a service. So, if you’re manufacturing entertainment units that are custom-built for a client’s home, including installation, you would need to charge your customer for both the unit and the time it’ll take you to install it.
As a startup business, you may be tempted to price your products or services lower than your competitors. However, customers may interpret low prices as a sign that you lack confidence and experience. You also don’t want to start a discounting battle against financially stronger competitors. Discounting can be worthwhile for special occasions, but only if it achieves your aims. As an example, discounting can help you sell off old inventory and improve your inventory.
Underpricing your products can be even more dangerous than overcharging. Remember that while prices are low, so too are your profit margins. It is easier to reduce prices than to increase them so when in doubt, try higher prices first. You may discover that your target market is not particularly price-sensitive.
Bundling additional products together and charging a package price can work well if the customer sees a greater increase in value than your actual additional costs.
It is a well-established pricing tactic in retail to use psychological price points. As an example, customers see $49.90 as being considerably less than $50.00.
With your sales projection in place, you are now ready to determine if your business idea is feasible. Continue your business planning journey with our next article in this series: 'How do you determine if your idea is financially feasible?'
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