Sales are recorded on a company's income statement, which summarizes the company's financial performance over a given period with respect to profits and losses. Business owners and investors perform sales forecasts for a wide variety of purposes, and use a wide variety of methods to do so. Projecting future sales involves a mix of quantitative and qualitative analysis. Historical trends are identified and reconciled with subjective data regarding market trends, and also with variables identified as correlating with sales growth.
Operational Planning and Goal Setting
Managers often share sales projections with employees to communicate the amount of work necessary to hit those numbers. Sales forecasts can be used to set goals, both company-wide and for individuals, and compensation may be tied to meeting these goals. Capital-intensive companies often adjust the capacity available, both human and machinery, in order to meet sales targets. Expected sales also impact the amount of inventory needed on hand. Projecting sales is a key step to managing the budget, as all variable costs will be driven by sales.
Financial Planning and Funding
Both creditors and investors routinely require sales forecasts, the results of which then are incorporated into their decision-making strategies. Creditors use sales forecasts to estimate the company's cash flow and debt coverage ability. Investors may use the sales forecast within a wide number of analyses, depending on the nature of their investment. Business owners typically need sales projections for financial planning and external funding purposes. For example, if sales are expected to grow substantially, a business owner may decide to take out a loan, which may be necessary to finance the growth.
Projecting Financial Statements
Sales forecasts generally are the first step to preparing a full set of projected financial statements. You can use projected sales as a basis for forecasting the entire income statement by using the percent of sales method. This method involves calculating income statement line items as a percent of sales.
For example, wages and compensations may equal an average of 30 percent over the past three years. Therefore, if next year's sales are projected to be $100,000, wages and compensation can be forecast to equal 30 percent of projected sales, or $30,000. This technique can be applied to all cost of goods sold and operating expense items, resulting in forecast net income. Balance sheet items can be projected using almost the same technique.
Benchmarking and Risk Management
Sales projections often are used for financial benchmarking purposes, comparing the company's expected performance with those of peer groups or competitors. This allows the business owner or investors to assess any expected changes in market share. Projected sales also are a key component of various risk management techniques. For example, banks perform gap analysis, which compares the bank's assets with its liabilities. The goal is to identify when any cash outflows are expected, such as a new loan issuance, and to ensure that a cash inflow of the same or similar size occurs at the same time to offset the liability. This mitigates interest rate risk. A huge variety of financial models rely on projected sales, including valuation models and goodwill impairment tests, which are necessary for financial reporting purposes.