3 Dangerous Myths About Sales Forecasting

Re: Well....

"How? Let's say I make a forecast and I use said forecast to make purchase decisions (lets assume 90 day invoices). Now, a lot will be dependent upon the quality of that forecast. If I was making a forecast based upon the previous years sales (say, a retail store gearing up for Christmas) I could be in a world of hurt (like when an economy goes belly up.) However, were I to limit myself to placing orders based upon current cash flow (i.e. the most recent sales figures...maybe just the previous month), you can keep from getting in over your head."

I think this plays into a lot of what Tim is saying. We shouldn't base forecasting specifically off of the previous years sales or off of what someone else is telling us. We should base the forecast off of what we believe to be right in our real world situation, use our knowledge of what is happening now to forecast and then review and revise these forecasts often.

If we just forecast based off of current cash flow with no thought to what happened last year, we can get into trouble as well. This time of year gives us a wonderful example, consider a Toy Store heading into the Holiday Season. I'm sure that all toy stores are feeling the economic pressures today like most businesses but if they only plan purchases for November and December based off of October's Sales and Cash Flow situations they'd find themselves with bare shelves in the height of the holiday season. Of course, if they only planned their purchases based on last years data, that would be bad as well.

I think the goal here is to forecast based off of real world situations and to review and revise those forecasts often. It's better to move forward with a plan than to move forward in the dark and review and revise that plan often rather than just close your eyes and follow the plan or rush forward with no plan and bump into walls.

Sean of OR @ Dec 04, 2008 15:53:10 PM

From the Trenches

I don't consider myself and expert, but I have done extensive forecasting for both in the corporate world and in a small, start up business.

Most non-finance folks have a pretty good handle on the the P&L (statement of profit and loss) where sales and expenses are projected. Where things get interesting is when you start projecting the balance sheet (assets and liabilities) and ulimately, cash flow.

Many a business has failed because they simply ran out of cash, not because they didn't have a viable concept. A company can show positive net income and run out of cash. This problem can get particularly acute in a rapidly growing business. Cash is rapidly consumed building inventory, hiring additional staff, equipment, customers paying late, etc. Before you know it, all of your cash is gone.

If you want to get outside financing, you will need to show your investors and/or banker projections for all three (P&L, Balance sheet and Cash flow). Without these, you will come off like an amateur, and most lenders will not want to work with you.

If I sound like I am biased, I am because I see the value in planning. No one can predict the future exactly. Knowing how business variables affect cash is critical to long term success.

Pete of CO @ Dec 03, 2008 23:44:02 PM

From the Trenches

I don't consider myself and expert, but I have done extensive forecasting for both in the corporate world and in a small, start up business.

Most non-finance folks have a pretty good handle on the the P&L (statement of profit and loss) where sales and expenses are projected. Where things get interesting is when you start projecting the balance sheet (assets and liabilities) and ulimately, cash flow.

Many a business has failed because they simply ran out of cash, not because they didn't have a viable concept. A company can show positive net income and run out of cash. This problem can get particularly acute in a rapidly growing business. Cash is rapidly consumed building inventory, hiring additional staff, equipment, customers paying late, etc. Before you know it, all of your cash is gone.

If you want to get outside financing, you will need to show your investors and/or banker projections for all three (P&L, Balance sheet and Cash flow). Without these, you will come off like an amateur, and most lenders will not want to work with you.

If I sound like I am biased, I am because I see the value in planning. No one can predict the future exactly. Knowing how business variables affect cash is critical to long term success.

Pete of CO @ Dec 03, 2008 23:40:47 PM

Well....

...I teach at a University these days as well (its a weird world)...so my comment wasn;t really directed at your teaching gig. It just seemed to be the type of impractical approach university types would espouse. Really, no offense was intended.

"2. I agree with the previous commentator too, but not at all with the idea that forecasting takes flexibility away. Forecasting gives you the flexibility of managing proactively, instead of constantly playing catch-up reactively."

How? Let's say I make a forecast and I use said forecast to make purchase decisions (lets assume 90 day invoices). Now, a lot will be dependent upon the quality of that forecast. If I was making a forecast based upon the previous years sales (say, a retail store gearing up for Christmas) I could be in a world of hurt (like when an economy goes belly up.) However, were I to limit myself to placing orders based upon current cash flow (i.e. the most recent sales figures...maybe just the previous month), you can keep from getting in over your head. And this is what most small businesses wind up doing. If you had access to a large line of credit to CYA, then, OK, using a forecast could be useful to maximize profits, but that isn't an option for lots of small businesses.

Now, basing your ability to make purchases upon current cash flow would NOT be a forecast (in any common usage of the word.) And that would certainly be an approach for someone in charge of inventory.

Rich Horton of WI @ Dec 03, 2008 23:03:42 PM

Double What

Hey Rich, re "you folks who teach business at universities," you're writing that to somebody who's been running my own business since 1983, and built my latest one -- Palo Alto Software -- from zero to multimillion dollar sales and 45 employees without outside investment. Yes, I teach one class a year now, but please call it nonsense if you think so, but not just because I now teach a class.

1. No, I don't say forecasts have little to do with what happens. On the contrary, I'm saying it takes a forecast to even figure out what did happen. And it no more takes time and energy away from managing than having a route planned takes time and energy away from driving.

2. I agree with the previous commentator too, but not at all with the idea that forecasting takes flexibility away. Forecasting gives you the flexibility of managing proactively, instead of constantly playing catch-up reactively.

3. The wild guess is what happens when you don't forecast. If you do forecast, you've got real data to steer with after the end of a single month. Aren't you contradicting yourself when you don't want forecasting but cite the inventory buyer as an example? If she's not basing that buy on a forecast -- and hopefully a managed and reviewed forecast with lots of plan vs. actual -- then what is she basing it on?

Tim Berry of OR @ Dec 03, 2008 15:25:12 PM

What?

Speaking as someone who ran a small business for a number of years, a lot of this strikes me as nonsense. I mean, I'm sure this is the way folks who teach business in universities want the world to work, but it is as far from the real world as I can imagine.

1. You admit up front that the "forecasts" have little to do with what actually happens. This is not a "so what" moment. Producing these "forecasts" take time and energy away from other things one could be doing. In any small business there are never enough hours in the day to do what needs to be done. Even the most cursory of a cost/benefit analysis would tell you to dump the attempts at "forecasting" as being, at best, non-productive, and, at worst, counter-productive.

2. I agree with the previous commentator; flexibility is the key. Forecasts can have the unintended effect of narrowing our options based upon what we believed would happen, as opposed to what actually happens. Yes, the author says you have to keep evaluating your situation, but how does a "forecast" help you do that? One could just as easily (or more easily) rely upon sales history (for example) to give one a comparison with present numbers.

3. It is a good rule of thumb to always be wary of what my father used to call "Onageristic Estimates." (An onager is the name of a wild ass....so an Onageristic Estimate is a "wild ass guess.") Such guesses were only employed when other methods/answers were, A) unavailable, or B) too costly (in one way or another.) You believed in an Onageristic Estimate at your own peril. The thought of an inventory manager basing her buying upon such a number should send shivers of horror through the mind of any samll business owner.

Rich Horton of WI @ Dec 03, 2008 14:13:22 PM