Ben Rybicki of Doeren Mayhew
By Ben Rybicki, CPA – Shareholder, Doeren Mayhew

“If you don’t know where you’re going, you’ll never know if you get there.”

This time-tested adage holds especially true when it comes to forecasting. Businesses today have enjoyed ten-plus years of growth, success and prosperity. However, given business uncertainty today, and the cyclical nature of the business environment businesses operate in, future forecasting is essential for planning, asset management and maximizing shareholder return on investment. Owners and leadership teams must make accurate forecasts of their sales, cost of sales, and operating and administrative costs to assist them in making effective business decisions concerning the allocation of their resources and management of cash flow.

Forecasting or Guessing?

Some business owners acknowledge they already perform forecasting. However, their forecasts may be a little more than educated guesses. For example, one assumption business owners choose to make is they will ask their sales managers how much of a specific product they expect to sell in the upcoming month as a basis for their forecasting. Managers may provide their best guesstimates rather than digging deeper into the facts supporting the assumptions needed to build out a more accurate forecast.

There is a big difference between real forecasting and educated guessing. A true forecast considers several factors, including the following:

Seasonal/Cycle Trends
These are derived by evaluating historical sales numbers to see how seasonality, industry specific factors or market cycles affects sales. In addition, companies also need to review current sales orders, planned purchase orders in the pipeline and other factors that may impact future sales activities. One example indicator for sales forecasting may include reviewing the sales figures from last January, which may be a good indication of what sales this January will look like, unless industry specific or other factors (i.e., interest rate changes, labor strife, liquidity concerns) have impacted the business climate in which the company operates.

Current Trends
Current trends may be derived by using recent monthly sales figures to get an idea of current planned sales activity. Based on these numbers, you can create a simple moving average of sales over the past few weeks or months to assist with your future forecasting. A simple example includes the past three months’ sales for a specific product which total 80, 120 and 100. The moving average for this three-month period would be 100 of this specific product (300 total products sold divided by 3 months). Examining recent sales trends provides additional facts to better understand the current sales environment the company is operating in.

Historical sales trends may also be helpful when evaluating current monthly sales forecasts if the industry has consistent sales year-over-year for those months. For example, if a company is a retailer who sells merchandise to Christmas shopping customers, then their sales for November and December each year will be higher than other months of the year and may be consistent each year if they have the same number of retail locations. Those Christmas sales may need to be adjusted significantly higher if that retailer now utilizes an internet sales platform. These are factors that would be considered in adjusting your planned forecast.

Once the sales forecast is complete, then the company’s focus shifts to expense forecasting. This can be a straightforward process, but still requires well thought-out assumptions. A company will need to assess their cost of sales based on their sales forecast using a rolling average of monthly cost of sales or a historical benchmark. The net of sales and cost of sales equals the forecasted gross profit for the business.

A company may want to review their general administrative costs and overhead for potential forecast changes — items such as employee salaries, rent, utilities and data processing should be assessed for any changes impacting the company’s forecast. Variable expenses which may include advertising, sales compensation and policy adjustments should be analyzed. Variable and administrative expenses will need to be totaled and subtracted from gross profit to arrive at net profit before other income and expense items (interest expense, interest income, etc.). Variable expenses may vary depending on sales volume, so you may want to base your forecasts on a per-unit basis or a percentage of projected sales basis.

Frequency of Forecasting

Forecasting can be completed on an annual, quarterly or monthly basis. Many businesses are moving away from static annual forecasting because so many things can change over the course of a year that renders the original forecast obsolete. Instead, businesses are adopting dynamic monthly and quarterly rolling forecasts. These types of forecasts tend to be more accurate and reflect what’s happening in the marketplace now.

You may find it helpful to meet with your managers off-site to create the next month’s or quarter’s forecast. This eliminates office distractions and allows managers to focus on the task at hand. It also encourages input from each other concerning their assumptions and how they arrived at them.

Spending a half-day off-site working on forecasts with your managers can pay off handsomely by providing you with more accurate and actionable numbers. It also helps get buy-in from your managers — those responsible for making the forecasts happen.

Improve Operational Performance

If your forecasting process consists of more guesstimating than real forecasting, now is a good time to launch some of these ideas before next year. Improving the accuracy of your forecasts protects company resources, provides for enhanced accountability, and can result in better operational performance and return on investment for your company. To get help in setting up your forecasting model, contact Doeren Mayhew’s team of CPAs and business advisors. We’re here to help you improve your performance and bottom line.