A sales budget is a crucial factor for any business and is the foundation for all other budgets. It acts as a method of control and planning and provides a roadmap to achieve financial objectives and allocate resources.
Many businesses have trouble with setting a sales budget because it often relies on forecasting. Depending on the type of business there is enormous pressure to get the budget right and failure to do so can have significant impact on the business. Think about a manufacturing firm which needs to import rare raw materials with long lead times for its product range. Incorrectly setting the sales budget will impact on inventory levels and other operational factors such as labour. Underestimating the number of units sold will leave the manufacturer unable to meet demand, and due to lead-times, unable to obtain the materials quickly. Underestimating the sales budget impacts equally on labour requirements. Due to unplanned demand the manufacturer may need to quickly employ and train more personnel, assign additional shifts or purchase more equipment. These are activities which cannot be achieved overnight and the result may be loss of customers, contracts and reputation. Of course, over estimating sales budgets creates similar problems which will impact on the business.
As sales forecast are the basis for setting the sales budget, how is this done given the variability of markets and not having the benefit of a crystal ball? Well, it’s not an exact science but is based on several factors as follows.
- Past sales volume
- Economic conditions
- Market research information
- Pricing policies and their impact on demand
- Quality of sales force
- Customer feedback and data
- New and existing contracts
- Competition and availability of substitutes
- Seasonal variation
- Unfilled backlogs
- Gut feeling (yes, that’s right!)
There are a number of approaches to forecasting sales but I will consider just two
- Macro approach – Forecasting total sales
- Micro approach – Forecast sales by product, service, customer, territory or salesperson.
The macro approach is based around a mathematical model which identifies the relationship between variables and company sales. The model revolves around statistics to measure these relationships. An example may be a driving instructor school and the benefit to them of knowing how many learners permits are issued per year. Another example is a buildings products manufacturer. They would be interested in how many building and development applications are approved by local councils. Another method which rides on the macro approach is to forecast sales based on your market share. If research indicates that your business operates in a 20 million dollar market, and you have 10% of that market, then a sales budget can be estimated. I would be wary of too much reliance on this method. The statistics could be wrong or your market share can be impacted by new competitors and products or simply changes in buyer behaviour.
The micro approach relies more on internal company information such as feedback from customers and the sales team. Tools such as a CRM are invaluable in this regard. The weakness of the micro approach is the bias of people making the predictions. The sales team may be too optimistic with their expected pipeline and customers may give inflated figures to negotiate better pricing. A method to guard against bias is to record actual results against predicted results over a long period of time. This allows management to make the necessary adjustments to sales forecast.