What is Sales Forecasting? Role, Types, Selection of Forecasting

What is Sales Forecasting?

Sales forecasting is the process of estimating future sales volumes, revenue, and profitability for a particular product, service, or business. It involves analyzing historical sales data, market trends, customer behavior, and other relevant factors to predict how much a company is likely to sell in the future. The goal of sales forecasting is to help businesses make informed decisions about production, inventory, staffing, and other aspects of their operations.

Meaning & Nature of Sales Forecasting

A forecast may be defined as an indicator of what is likely to happen in a given time frame in the future, generally based on available data. From this definition of a forecast, we can say that a sales forecast is an indicator of the amount of a product or service a business is likely to sell in a given time frame in the future in a given market at a given price. That is, a sales forecast is an estimate of the future sales potential of an organisation.

Accurate sales forecasting allows an enterprise to produce the required quantity at the right time. The sales forecast forms a basis for production targets. It also allows it to plan ahead for budgets, raw materials, equipment, labour, pricing, etc.

Sales forecasting plays the following role in an organisation:

• Help visualise the revenue goals: Sales forecasting provides all the stakeholders with a good understanding of the revenue goals for the specified time frame. Visualisation of the revenue goals helps to anticipate cash flow and growth of the organisation and measure the performance against it. It also helps to prepare for any issues that may occur down the line.
  
  
• Manage and monitor sales performance: Sales forecasts help to manage the sales team and monitor its performance against the sales goals. It helps organisations develop and execute a plan for the given period and adapt if things do not go according to plan.
  
  
• Help with high-level decisions: Accurate sales forecasts provide information that helps the top management take decisions regarding expansion, growth, investments, etc.
  
  
• Plan for the cash flow: Sales forecast aid the finance department in planning for the cash flow to cover the expenses.
  
  
• Prepare for after-sales support: Sales forecasts prepare the customer service team for after-sales support.

Apart from the above, sales forecasting plays a very important role in manufacturing businesses as it helps with the following:

• It helps to determine production volumes
  
  
• It helps to determine plant capacity, equipment, capital and manpower requirements, etc.
  
  
• It helps to establish the sales and production budgets
  
  
• It helps in pricing decisions
  
  
• It aids in advertising decisions
  
  
• It aids in decisions regarding expansion, production mix, etc.
  
  
• It helps in making production and purchasing schedules
  
  
• It aids in developing strategies that will help in achieving the targets that have been predicted by the sales forecasts

Type of Forecasting

Short-term Forecasting

This type of forecasting is limited to a short period, usually up to one year and aids in the following areas:

• Determining production schedules: Production schedules have to be developed according to predicted sales volume to avoid the problem of both overproduction and under-production.
  
  
• Pricing decisions: Sales forecasts help to devise a suitable price policy.
  
  
• Purchasing of raw materials: An understanding of sales in the immediate future allows firms to estimate production scales and purchase raw materials as needed.
  
  
• Setting sales targets: An understanding of future sales levels in the near future will allow managers to adjust sales targets accordingly. If sales targets are set too high, salespersons find them impossible to meet,whereas if sales targets are set too low, the targets are met too easily, and incentives amount to nothing.
  
  
• Advertising and promotion decisions: An estimate of sales levels in the near future allows firms to plan their advertising and sales promotion accordingly.
  
  
• Short-term financial requirements: Estimating sales and production scales allows firms to estimate short-term financial requirements.

Long-term Forecasting

This type of forecasting refers to a period of forecasting more than one year. The element of uncertainty is higher in long-term forecasting.

It is more relevant to the planning of:

• Expansion of an existing unit or opening a new unit
• Long-term financial requirements
• Personnel requirements
• Rate of maintenance of equipment and plant
• Raw material requirements over a long-term

For any sales forecast, the following things must be factored in:

• Competition: Existing and new competitors’ offerings play an important role in deciding the demand and thus, the future sales of a product or service.
  
  
• Technological advances: Technological advances introduce new products and new trends in the market and change the demand for a product or service.
  
  
• Government policies: Sales of products and services are influenced by government policies and regulations.
  
  
• Internal factors: Internal factors related to plant capacity, changes in product mix, etc., should be factored in.

Basis for Selecting a Suitable Forecasting Method

Seeing the valuable role that forecasting plays in long-term business planning and the growth and success of an organisation, it is critical to select the right forecasting method for your organisation. Forecasting enables managers to manage seasonality, changes in trends, sudden changes in pricing or promotion strategies by the competition, sudden changes in the economy, etc.

A forecast can only provide the right answers when the right questions are asked, and the right techniques are applied. Over the years, many forecasting techniques have become available to managers.

Each technique has its merits and limitations and the forecaster has to apply the right technique to get the right answer. Therefore, in this section, we will discuss the selection of a suitable forecasting method.

The selection of a method depends on many factors as given below:

• The purpose of the forecast
• The cost/benefit of the forecast
• The availability of historical data
• The range of the forecast
• The time available for making the analysis
• In the case of a particular product, the stage of the product’s life cycle

Factors that Influence of Selection of Forecasting Method

Purpose of the Forecast

The first and foremost criterion in the selection of a suitable method is the objective behind doing the forecast. The reason behind the forecast determines how accurate the forecast needs to be. For example, a forecast to estimate sales when entering a new market may not need to be very accurate, but a forecast for budgeting purposes needs to be quite accurate.

Cost/benefit of the Forecast

Forecasting techniques vary in their costs; therefore, the forecaster must decide the level of inaccuracy they can accept as a trade-off between cost and the value of accuracy in choosing a technique.

Availability of Historical Data

The availability of historical data is important when considering. It is also important to determine whether past data is relevant and how much. Qualitative techniques use qualitative data, such as expert judgement while quantitative techniquesrely completely on historical data.

Range of the Forecast

The objectives can range from shortterm decisions, such as the immediate requirements of raw material or transport to long-term decisions regarding production capacity, expansion, financial requirements and policy. For shortterm objectives, the past still has a major influence on demand. For this reason, time series forecasting is better for short and medium-term objectives.

To account for other factors, the time series analysis can be modified by expert opinion. In contrast, causal models, though more complex, are more appropriate for long-term forecasting since there is plenty of time for the implemented strategies to have an effectThe objectives can range from short-term decisions, such as the immediate requirements of raw material or transport to long-term decisions regarding production capacity, expansion, financial requirements and policy.

For short term objectives, the past still has a major influence on demand. For this reason, time series forecasting is better for short and medium-term objectives. To account for other factors, the time series analysis can be modified by expert opinion. In contrast, causal models, though more complex, are more appropriate for long-term forecasting since there is plenty of time for the implemented strategies to have an effect.

Time Available for Making the Analysis

The selection of the forecasting method depends on how much time is available to make the forecast.

Stage of the Product’s Life Cycle

If the forecast is to be made for a particular product, the stage of the product’s life cycle is considered when selecting the method. This is because the maturity of a product directly determines the availability of data and being able to quantify the associations between the factors.