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Start It Up

How do you forecast sales for your start-up business?

Alvin Fritschle

By Alvin Fritschle

Alvin Fritschle is the Chairman of the Board of First Bank, a community bank serving Southeastern Illinois and Southwestern Indiana. He has provided financial advice to numerous entrepreneurs for over 40 years as a certified public accountant and the President of First Bank. Over this time, he has demonstrated a strong commitment to assisting his clients with their strategic decisions.

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.

Sources of information for your sales forecast

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.

  1. Trade associations and the Internet are excellent sources of data to support your sales forecasts. These trade publications often contain good information on industry sales volume and sales trends for specific industries. These publications also break down sales by region.
  2. Vendors are also a good source of information to assist you in projecting your sales. Vendors may have experience with supplying other startups in your industry, which can be a starting point for your sales forecast. Just remember to stay cautious when dealing with vendors. After all, they are in the business to sell their products and may tell you what you want to hear rather than what you need to know.
  3. The Census Bureau is another good source of data to back up your sales forecast. At their website you can get data to back up the size of your market. This includes demographic information like age, sex, income distributions, and number of households. The Census Bureau also tracks various economic data like sales volume by industry and market. While this data may be a few years out of date, the Census Bureau often updates it periodically.

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.

Preparing 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:

  • It is often easier to begin your sales projection by projecting the units of sales by month. Not all businesses sell by the unit; however, if you can break down your sales into units or components, it is easier to do a sales projection. If you are in a professional service industry, your unit may be hours of consulting or number of jobs.
  • If you are purchasing an existing business, historical sales data is a great place to start. Take the past three years and graph sales by month. This graph will show you if there are seasonal fluctuations in sales as well as the overall trend line, whether positive or negative. If you are projecting sales that are significantly different than these trendlines, you will have to justify that difference to investors and financial institutions. Investors and financial institutions place a great deal of value on conservative common sense, so conservative and logical sales projections will go a long way in convincing them you know what you are doing.
  • The next step in projecting sales is to break down your sales into various components. The profit margins on different components are normally different and can impact your profitability significantly. For example, the profit margin on items sold inside of a convenience store is greater than the profit margin on gasoline sold at the pump. Chain convenience stores often project inside sales by the square foot (an industry metric that is available).

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.

Developing a pricing strategy

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:

  1. What the market says
    You can get valuable guidance by conducting research on the market’s reaction to products or services similar to your own.
    • Which are seen as offering the best value?
    • Which are likely to be the most successful?
    • What do customers expect to pay for them?
    • Is there an established market price for similar products or services?
  2. Your competitors
    To some degree, your price will depend on the competition. Look at your competitors, the key benefits and features of what they offer, and any points of difference you can see in your own product or service. If you’re able to offer more value (for example, better quality or more features), you can afford to charge a higher price.

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.

Cost-plus pricing strategy

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.

Margin retail pricing strategy

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?

Hourly rate pricing strategy

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.

A mix of margin retail and hourly pricing strategy

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.3

Other pricing tactics

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.

Take the next step!

With your sales projection in place, you are now ready to determine if your business idea is feasible.4 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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