In order to develop an effective business strategy, you need to be able to estimate future sales. But how can you do that?
Here’s our complete guide to sales forecasting…
- What is Sales Forecasting?
- What is Historical Sales Forecasting?
- How to Use Historical Sales Forecasting to Estimate Future Sales
- Common Sales Forecasting Pitfalls and How to Avoid Them
- But What if You Need to Forecast Sales for a Brand New Business?
- Grow Your Business Faster than You Ever Thought Possible With Sales Funnels!
What is Sales Forecasting?
Sales forecasting is the process of estimating future sales for a specific period of time (e.g. the next year).
In theory, one could argue that sales forecasting is just glorified guessing since no one can predict the future.
In practice, though, the more data your sales forecast is based on, the more likely it is to be accurate.
It’s this reliance on data that differentiates proper sales forecasting from simply making guesses and coming up with numbers that “feel right” to you.
Of course, it’s important to remember that even the most data-driven sales forecast is just a prediction, not reality!
What is Historical Sales Forecasting?
Historical sales forecasting is the process of using historical sales data to estimate future sales for a specific time period.
It’s considered to be the most accurate form of sales forecasting, which is why it’s also the most popular sales forecasting method out there.
How to Use Historical Sales Forecasting to Estimate Future Sales
So how can you use your company’s historical sales data to forecast future sales?
Analyze Your Historical Sales Data
Start by analyzing your historical sales data.
You want to look at:
- Annual trends – Pay attention to how sales ebb and flow throughout the year. In some industries, these patterns are obvious. Say, if you are selling snowboarding equipment, then you can expect your sales to increase in winter and decrease in summer. But in other industries, these patterns aren’t as obvious and can only be established by looking at the data.
- Marketing channels – Marketing is all about driving traffic to your sales funnel. But not all traffic is created equal: some of it is low-quality (unlikely to convert into paying customers) and some of it is high-quality (likely to convert to paying customers). You want to see how your marketing channels compare in terms of conversion rates. Don’t just look at which channel generates the most traffic, see which channel generates the most sales!
- Year-on-year growth – Is your business growing every year in terms of sales, revenue, and profit?
We recommend excluding both one-off lucky breaks and one-off disasters from your sales data unless you have a reason to believe that something like that is likely to happen in the foreseeable future.
Meaning, if a celebrity mentioned your product unprompted and that led to a spike in sales, you should exclude that spike from your data.
Same thing if there was an unexpected supply chain issue such as a factory shutting down that temporarily disrupted your sales.
You want to base your sales forecast on cleaned-up historical sales data that excludes fluctuations caused by random events.
Develop Baseline Estimates for the Most Important Metrics
Use historical data to develop baseline estimates for the most important business metrics such as:
- Customer acquisition cost (CAC)
- Customer lifetime value (CLV)
- Visitor-to-lead conversion rate
- Lead-to-customer conversion rate
- Customer-to-repeat customer conversion rate
Create a Conservative Sales Forecast
Use the annual trends, marketing channel data, year-on-year growth, and baseline estimates of the most important business metrics to create a conservative sales forecast that assumes that you simply continue doing what you have been doing so far.
Adjust Your Sales Forecast to Account for Future Plans
Once you have your conservative sales forecast, you can adjust it to account for the plans that you have for that time period.
Say, if after analyzing your sales data you realized that Facebook ads is your most effective marketing channel and decided to double down on it, you can adjust the numbers to reflect that.
Note that in that situation, you’d be doubling down on a proven marketing channel, so your forecast would be based on historical data.
This is very different from simply guessing how some brand new initiative such as a product launch might work out. We don’t recommend including guesses like that in your sales forecast at all.
Instead, assume that none of your new initiatives will work out. Yes, this is an extremely conservative approach, but it’s better to err on the side of caution than to be overly optimistic. We’ll discuss the optimism bias later in this article.
Adjust Your Sales Forecast to Account for the Latest Market Developments
The market is ever-changing.
There are always ambitious new entrants, cutting-edge technologies, and societal trends that can disrupt the status quo.
These new developments often take entrepreneurs by surprise but the truth is that they are often foreseeable if you pay close attention to what’s going on in your industry.
When you are doing sales forecasting, you want to do your best to predict upcoming market developments so that you can be prepared to face the changes head-on.
Common Sales Forecasting Pitfalls and How to Avoid Them
Here are the five most common issues that can get you in trouble when you are doing sales forecasting:
Optimism Bias
Optimism bias is a cognitive bias that makes people underestimate the likelihood of negative events and overestimate the likelihood of positive events.
It has been demonstrated that people believe that they are less likely to become crime victims, get lung cancer due to smoking, or injure themselves while engaging in dangerous physical activities such as bungee humping.
We can probably safely assume that underestimating the likelihood of these negative events makes them take risks that they may not have taken had their decision-making process not been distorted by the optimism bias.
In the context of sales forecasting, optimism bias manifests as being overly optimistic about a new marketing strategy, a promising partnership, or a product launch that you are excited about, assuming that it will be a success, and then making decisions in the present based on this assumption about the future.
Say, if you are launching a new product, you can do all kinds of calculations to figure out how many sales you can expect. But these predictions aren’t reality. You don’t know how that launch is going to go.
Consequently, it would be a really bad idea to make business decisions based on the assumption that the launch is going to go as expected (e.g. taking on new financial obligations because you think that the money you’ll make during the launch will cover them). Never count your chickens before they hatch!
Lack of Systems Thinking
A business is a system where everything affects everything else.
That’s why you can’t just look at one of its components in isolation, make changes to it without considering the downstream effects of those changes, and expect everything to work out just as you intended.
Lead generation myopia is a good example of this. If you focus on lead generation in isolation without considering the downstream effects it will have on your sales funnel, you might end up sacrificing lead quality for lead quantity.
This can lead to spinning your wheels in a situation where you are bringing in more leads without it resulting in more sales. In extreme cases, you might even find that you are generating more leads than ever but your sales are declining!
When you are creating a sales forecast, make sure to account for how changes that you make in one area of your business might affect everything else in it. Otherwise, you might end up being taken aback by the predictable consequences of your own decisions!
Failing to Account for Toxic Company Culture
It’s important to make sure that the information that reaches you is accurate.
What you need ask yourself is this: do employees at all levels of your company feel that they can be honest with their superiors?
The unfortunate reality is that some companies develop a toxic culture where honesty is punished and dishonesty is rewarded.
Say, if the head of a department has a habit of throwing a temper tantrum whenever someone points out that their desired deadline is unrealistic, their subordinates will eventually stop pointing it out.
Instead, they will just nod and pretend to go along with it despite knowing full well that they are going to miss that deadline. And then, when they do miss it, it’s going to mess up the timeline for that project.
And if that’s a complex project involving multiple teams across several departments, it can throw the entire company into chaos. Say goodbye to your sales projections for that year!
If you ever find yourself confused as to why your data-driven sales forecasts turn out to be wildly inaccurate, consider the possibility that someone, somewhere might be being dishonest. Maybe even several people at several different levels of the company hierarchy.
In that case, by the time information reaches you, it may be so distorted as to be indistinguishable from fiction. And you can’t expect to create an accurate sales forecast based on fiction!
Failing to Realize that You Have Built a House of Cards
Sometimes entrepreneurs don’t realize that their companies are unstable due to the inherent fragility of their business model.
Businesses that are built around a specific trend are the most obvious example of this. Say, fidget spinners were all the rage back in 2017 but they are long forgotten by now. The demand for them is extremely low compared to what it was at the peak of this trend.
It’s okay to capitalize on trends but you need to realize that it’s not a sustainable way to make money. Sure, some trends stay and become a part of the culture, but most of them fade into oblivion.
Businesses that sell bad products are another example. If you have a massive marketing budget, you can sell pretty much any product, no matter how terrible it is. However, the sales will soon start declining due to bad reviews, customers complaining on social media, negative publicity, etc.
While it is possible to make money with this approach, it’s not only ethically dubious but also unwise in the long run. Once the word about how terrible your product is gets out, your brand will be ruined. It can also do serious damage to your personal reputation and get in the way of building another business in the future.
Finally, there are “businesses” that are outright scams, which not only are unsustainable for the same reason as bad product businesses but can also get you in trouble with the law.
When you are doing sales forecasting, it’s important to appraise the situation honestly: is your business model sustainable?
If it’s not, then you’d probably be better off pivoting to something that has long-term potential. Creating sales projections for a business that can collapse at any moment is a waste of time!
Resting on Your Laurels as a Market Leader
Finally, if you are a market leader, it’s easy to become complacent.
At any given point in time, if you look at any industry, the leaders seem invincible… Until someone else comes along and steals their market share.
Here’s what tends to happen: an entrepreneur spots a gap in the market, launches an innovative product, and finds success. Great, right?
But the problem is that as time goes on, complacency sets in and the once-innovative product starts becoming increasingly outdated.
However, customers still use it begrudgingly simply out of inertia… Until some ambitious new entrant launches an obviously superior product!
This takes the market leader by surprise because they have come to believe that they are invincible. But while they were resting on their laurels, the world has moved on!
Doing sales forecasting offers a great opportunity to reflect on the overall state of your business. Are you continuing to improve your product or have you become complacent?
If your sales projections rely on customer inertia instead of on having a genuinely good product, your business is in big trouble!
But What if You Need to Forecast Sales for a Brand New Business?
So far we have discussed how to create sales projections for an existing business based on historical sales data. But what if you need to forecast sales for a brand-new business?
Consider analyzing industry data, various market trends, and any information that you can get on your main competitors.
Realistically, without historical sales data, this is going to be closer to guessing than it will be to proper sales forecasting.
Still, the more research you do, the higher the likelihood that your forecast will be at least somewhat accurate.
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