There are dozens of decisions to make every day when running your own business. Many are about money: Should we hire a new accounting assistant? Do we need to update our computers? How much should we spend on digital ads next month?
Answering these questions can feel like guesswork. After all, how can you make decisions about your spending without knowing the future?
This is where sales forecasting comes in. A viable sales forecast won’t predict the future, but it does help you see what the future could look like so you can make better business decisions.
What is a sales forecast?
A sales forecast is a document that predicts your business’s future sales. You can make one with a spreadsheet, CRM, or a forecasting tool. Sales forecasts are typically made to predict a year’s worth of sales, but can be made to look as short as a few months or up to five years ahead.
These forecasts are usually created by sales leaders to help set targets for their reps. However, they can also be created by:
- Executives, to plan budgets
- Marketing teams, to set customer acquisition goals
- Entrepreneurs, to help raise money
- Small-business owners, to make operational decisions
For each of these groups, a sales forecast can be a powerful budgeting tool. Once you have an estimate of your future revenue, you can review other costs—like the cost of goods sold and advertising spend—to ensure you’re left with a more accurate estimated profit.
A sales forecast can also help you plan ahead for fluctuations. If you run a candle company, for example, a sales forecast may help you prepare for the busy gift-giving season in November and December, and slower sales during the hotter months like July and August.
Factors that can affect a sales forecast
Accurate sales forecasts are based on a series of assumptions about your business’s future. Although you can’t precisely predict the future, you can estimate what it’ll look like by considering various types of sales factors.
Three types of factors that can inform a sales forecast, either positively or negatively. Their scope of impact depends on the business and its forecasting methodology:
1. Internal factors
Internal factors are plans made within your business that affect sales, including its marketing and sales strategy. These are the factors most within your control.
For example, if you plan on doubling your advertising spend next year, you likely expect this to increase sales. Other examples of internal factors include new product releases, restocking products, planning a sale or pricing changes, and brand/influencer partnerships.
2. External factors
By comparison, external factors are events or changes outside your business that may affect its sales. Your business typically has little to no control over these factors.
For example, if you sell sporting goods, you may think an upcoming FIFA World Cup will lead to more interest in soccer goods, and therefore, increased sales. Other examples of anticipated external factors that may affect sales forecasts include a recession, supply chain issues, new competitors, or fewer competitors.
Of course, there is always the possibility of so-called “black swan” events. These are external negative events like a pandemic, which no one can predict. When forecasting, the goal is only to define the external factors that you can foresee.
3. Historical factors
Pre-existing trends can also affect sales, especially if they’re expected to continue—like seasonal trends. If you’re a company that sells reusable lunch bags, you might do a seasonal forecast that shows higher back-to-school sales in August and September, and lower sales around June, when school is out.
Business momentum, or historical growth rate, is another trend to watch. If your sales have consistently grown 5% each month, it would be reasonable to expect that trend to continue.
Lastly, consider historical market factors like interest rate trends and consumer spending. If market research shows that sales in your industry are growing or declining year-over-year, factor that into your forecast.
Choosing a sales forecasting method
When it comes to predicting future sales, there is more than one approach you can take. There are two main sales forecasting methods:
1. Growth rate-based forecasting
Mathematically, growth rate-based forecasting is the simplest method to embrace. (It’s also known as “top-down” forecasting because it starts with high-level data to calculate revenue.) To estimate sales for the year ahead, simply take the previous sales data and apply the same growth rate from the previous year.
Here is the formula to calculate your growth rate percentage:
Previous period’s sales − Sales of period before that / Sales of period before that × 100 = Growth rate percentage
The equation to calculate your forecast based on these growth rates is:
Previous period’s sales × Growth rate percentage = Forecasted sales growth
For example, let’s say your business made $300,000 in sales in 2021 (the previous period), and $250,000 in 2020 (the period before that). This would be a growth rate percentage of 20%:
$300,000 − $250,000 / $250,000 × 100 = 20%
You may forecast that your business will again grow 20% in 2022:
$300,000 × 20% (or .2) = $60,000, for a total sales estimate of $360,000 ($300,000 + $60,000)
If you can’t rely on your growth rate from the previous period—for example, if you’ve only been in business for a year or less—you can use market research from your overall industry to forecast your growth rate instead.
2. Acquisition-based forecasting
With acquisition-based forecasting, you work backward to calculate your revenue based on robust predictions about the internal factors that drive your sales. This is also called “bottom-up” forecasting because it starts with your costs that drive revenue, such as advertising spend or sales staff. These are located below revenue on your income statement.
Acquisition-based forecasting looks slightly different for business-to-consumer (B2C) and business-to-business (B2B) businesses. For example, with a B2C business, you might start by considering how many sales you make “organically” (meaning without an advertising spend) each month based on past sales data. Then, estimate how many sales you’ll drive through performance marketing efforts, using the following series of factors:
- Cost per acquisition through ads. Another way to think of cost per acquisition, or CPA, is: How much do you expect to spend to acquire one new purchase?
- Average order value of those sales. Average order value (AOV), is a metric that answers: How much does a customer spend on an average purchase?
- Advertising budget. Your advertising budget is how much you plan to spend on advertising over a month.
For example, you might make $10,000 in sales per month through organic social media marketing. You then drive additional sales via search engine ads at $40 per purchase, with the average purchaser spending $100. You know if you spend $5,000 on ads, you’ll drive 125 sales ($5,000/$40) , worth $12,500 (125 x $100) .
The formula is:
Organic revenue + (Advertising budget / Cost per acquisition) × Average order value = Forecasted Revenue
The forecasted revenue, or total sales per month, in this example is $22,500:
$10,000 + ($5,000 / $40) × $100 = $22,500
For B2B businesses, the math is a little different, but follows the same principles. Instead of using advertising spend, B2B teams look at their sales pipeline—the contract value of all the deals with sales prospects, adjusted based on their likeliness to close.
Any given business needs to determine for itself how to calculate its cost per acquisition or sales pipeline based on its unique circumstances.
Some businesses create “hybrid” forecasts that consider both growth rates and acquisition assumptions. This is called multivariable analysis forecasting, and requires a more in-depth forecasting model.
Creating a sales forecast
There are four steps to creating a viable sales forecast:
- Pick your method of forecasting (growth rate or acquisition based). If you have a couple of years of sales already under your company’s belt, you may be able to use growth rate forecasting. However, if you’re a new company that has information about how much you’re spending to drive sales (such as spend on ads or sales reps), you could use acquisition-based forecasting.
- Pick your forecasting period. Choose a forecasting period that works for your company. Some companies and industries have sales fluctuations from one month to the next, meaning that spreading your forecast over a longer period (such as a year) might make sense. Other companies might have stable sales throughout the year, meaning a shorter period (such as three months) might provide a sufficient picture of your company’s operations.
- Determine your key internal and external assumptions. Internal assumptions that affect sales forecast might be an increase (or decrease) in ad or marketing spend. External factors may be logistical delays that affect your product supply or an upcoming event that increases interest in your product. Finally, historical factors and seasonal trends (like back to school) may also be at play when forecasting sales.
- Compile the data in a spreadsheet. A typical sales forecast spreadsheet will usually have one month per column and at least three rows: Revenue, Growth Rate, and Assumptions, with one row per type of internal, external, or historical assumption.
Sales forecasts FAQ
How do you calculate a sales forecast?
The simplest formula to use is: sales forecast = the previous period’s sales + estimated growth (or shrinkage) in sales for the next period.
The estimated growth can be calculated using a growth rate-based (top down) approach or an acquisition-based (bottom up) approach, using key assumptions about your business and the world around it.
What are the two basic forecasting methods?
The two basic forecast methods are growth rate-based (sometimes called top-down forecasting) and acquisition-based (also known as bottom-up forecasting).
Why is sales forecasting important?
Sales forecasting is important for three reasons:
- It forces you to consider strategic assumptions about your business.
- It helps you set budgets in your overall projections.
- It helps you plan ahead.