Sales forecasting is basic to any business plan or budget and to some investment analysis. Essentially, you need to collect information for, or make forecasts concerning, as many as five related variables.
For example, you typically need to collect the units and dollars of inventory that you already hold or that you estimate you will hold at the beginning of the sales forecast. In a manufacturing firm, these amounts are the sum of the work in process, or partially manufactured, inventory and the finished goods, or ready to sell, inventory. In a wholesaling or retailing firm, these amounts are the sum of those items purchased for resale. You need to collect both the units of inventory and the dollars of inventory. (In a service business, no inventory is manufactured or purchased, so these amounts are 0.)
Second, for each period in the forecasting horizon, you need to forecast the number of units produced if you’re a manufacturer or the number of units purchased if you’re a wholesaler or retailer. Typically, the amounts cannot be forecasted independent of sales, but sales isn’t the only variable that affects production or purchases. Other important variables such as manufacturing capacities and availability of inventory items to be purchased also impact planned production and purchases.
Third, you need to forecast the costs of producing or purchasing the inventory for each period over the forecasting horizon. For a manufacturing firm, costs are often forecasted by classifications such as direct labor (the wages and employee benefits incurred in making the item), direct material (the raw materials and components that go into the finished product), and factory overhead (the miscellaneous and incidental costs associated with making the item, such as electricity to run the manufacturing equipment). For wholesalers and retailers, forecasted costs are the amounts paid to suppliers for those items purchased for resale. In a service business, no inventory is manufactured or purchased, so no production or purchase costs exist.
Fourth, you need to forecast the number of units sold and the price per unit sold for each period over the forecasting horizon. For manufacturers, wholesalers, and retailers, the unit forecast simply is the number of cars, shirts, or basketballs sold; the unit price forecast is simply the price at which these items are sold to the customer. For service firms, the unit forecast simply is the number of times a service is provided or the hours of work performed; the unit price forecast is simply the price at which the service or work is billed to the customer.
Fifth, you need to forecast any other variable costs associated with sales. For any type of business, these other costs might include sales commissions incurred as a result of the sale, taxes on the sale, and any other costs incurred and directly tied to the sale.
With this information, you should be able to forecast total sales, cost of sales, and margins. Usually when you forecast sales and cost of sales, you use either the financial accounting or managerial accounting format. Using the financial accounting format, you calculate sales revenue, cost of goods sold, and gross sales margin.
Using the managerial accounting format, you calculate the marginal sales revenue, the variable costs, and the marginal contribution. The marginal sales revenue is the number of units sold times the unit price at which the sales are made. The variable costs include both the cost of goods sold, which is the sum of the production or purchasing costs of the items sold, and also any other variable costs incurred as a result of the sale. The marginal contribution is the marginal sales revenue minus the variable costs. The marginal contribution is that amount generated by your sales to pay your fixed costs, those costs that do not vary with sales volumes. You might want to use a combination of both formats in your forecasting, so the sales and cost of sales starter workbook amounts to a hybrid of the two formats. You can use sales revenue for either the financial accounting sales revenue or the managerial accounting marginal sales revenue. You can use the cost of sales for either the financial accounting cost of goods sold or the managerial accounting variable costs. Depending on how you use the workbook’s sales revenue and cost of sales, you can use the gross margin for either the financial accounting gross sales margin or the managerial accounting marginal contribution. Total sales simply are the number of units sold times the unit price at which the sales are made. The cost of the goods sold is the sum of the production or purchasing costs of the items sold. The gross sales margin is the total sales less the cost of sales. The gross sales margin is that amount actually generated by your sales to pay for your operating and financing costs. Any amounts left over after paying these costs represent your profit.